A HELOC is a line of credit you borrow against using your home as collateral
A HELOC (home equity line of credit) is a revolving loan tied to the equity you have built in your home. Unlike a traditional second mortgage, which gives you one lump sum upfront, a HELOC works like a credit card — you can borrow, repay, and borrow again up to a maximum limit during a set period called the draw period. The lender holds a second mortgage on your property as security.
You only pay interest on the money you actually borrow, not on the full credit line. This makes a HELOC cheaper than a personal loan or credit card for large expenses, because your home secures the debt and interest rates are lower. The trade-off is that your home is at risk if you stop paying — the lender can foreclose just as they would on a first mortgage.
Most HELOCs have a draw period of 5 to 10 years, during which you can access funds. After that period ends, the repayment period begins, and you can no longer borrow. You then repay what you owe, usually over 10 to 20 years.
Key Takeaways
- A HELOC lets you borrow against your home's equity and access funds as you need them, paying interest only on what you use.
- Your home serves as collateral, so the lender can foreclose if you default on payments.
- Interest rates on HELOCs are usually variable, meaning your monthly payment can increase if rates rise.
- You need at least 15 to 20 percent equity in your home to open a HELOC, and lenders typically allow you to borrow 80 to 85 percent of your home's total value minus what you owe on your first mortgage.
- HELOCs work best for planned expenses you will pay off within the draw period, not for ongoing debt or emergencies you cannot repay quickly.
How much you can borrow depends on your home's value and what you owe
Lenders calculate your HELOC limit using your home's current market value and your existing mortgage balance. Most will let you borrow up to 80 or 85 percent of your home's value, minus what you still owe on your first mortgage. If your home is worth $300,000 and you owe $200,000 on your mortgage, your equity is $100,000. At an 80 percent loan-to-value ratio, you could borrow up to $40,000 (80 percent of $300,000 is $240,000, minus the $200,000 you owe).
Lenders require you to have at least 15 to 20 percent equity before they will open a HELOC. They also look at your credit score, income, and debt-to-income ratio — the same factors they use for a mortgage. A higher credit score and lower debt load will get you a better interest rate.
Interest rates on HELOCs are usually variable, not fixed
Most HELOCs come with a variable interest rate tied to an index like the prime rate. This means your rate — and your monthly payment — can change over time. When the Federal Reserve raises rates, your HELOC rate typically rises within a few months. When rates fall, your payment drops.
Some lenders offer a fixed-rate option for part or all of your HELOC balance, but this usually costs more upfront or comes with a higher rate than the variable option. A fixed rate protects you from payment shock if rates spike, but you pay for that protection.
During the draw period, many HELOCs require only interest-only payments. Once the draw period ends and the repayment period begins, your payment jumps because you now have to pay down the principal as well. This can be a surprise if you have not planned for it.
Costs and fees vary by lender and can add up quickly
Opening a HELOC involves costs similar to a mortgage: application fees, appraisal fees, title search fees, and closing costs. These typically range from $500 to $2,000 depending on your lender and location, though some lenders waive them. Some HELOCs also charge annual maintenance fees, inactivity fees if you do not use the line, or early closure fees if you pay it off before a certain date.
Interest rates vary by lender and by your creditworthiness. As of early 2024, variable HELOC rates range widely depending on the prime rate and your credit profile, so shopping around matters. A difference of even 0.5 percent can save or cost you thousands over the life of the loan.
When a HELOC makes sense and when it does not
A HELOC works well for planned, one-time expenses you can repay within the draw period — a kitchen renovation, a child's education, or paying off high-interest credit card debt. Because you only pay interest on what you borrow, you can draw funds gradually as you need them, which keeps your costs down.
A HELOC is risky for emergencies or ongoing expenses you cannot repay quickly. If you lose your job and cannot make payments, the lender can foreclose. If rates spike during the repayment period, your payment could double or triple, straining your budget. Do not open a HELOC unless you have a clear plan to repay it and a stable income to cover payments if rates rise.
How a HELOC differs from a home equity loan and a cash-out refinance
A home equity loan is a one-time loan for a fixed amount, with a fixed interest rate and a set repayment schedule. You get all the money at closing and start paying it back immediately. A HELOC is more flexible — you draw what you need, when you need it, and only pay interest on the balance you carry.
A cash-out refinance replaces your entire first mortgage with a new, larger one and gives you the difference in cash. This works if you want to lock in a lower rate on your first mortgage at the same time, but it resets your loan term and you pay closing costs on the full mortgage amount, not just the borrowed portion.
| Feature | HELOC | Home Equity Loan | Cash-Out Refinance |
|---|---|---|---|
| How you get the money | Draw as needed during draw period | Lump sum at closing | Lump sum at closing |
| Interest rate | Usually variable | Fixed | Fixed or variable |
| Repayment | Interest-only during draw period, then principal + interest | Principal + interest from the start | Principal + interest from the start |
| Best for | Ongoing or staged expenses | One-time large expense | Refinancing first mortgage + getting cash |
Frequently Asked Questions
Can I lose my home if I do not pay a HELOC?
Yes. A HELOC is secured by your home, so if you default on payments, the lender can foreclose and sell your house to recover what you owe. This makes a HELOC riskier than an unsecured loan like a credit card, even though the interest rate is lower.
What happens to my HELOC if interest rates go up?
If your HELOC has a variable rate, your interest rate and monthly payment will increase when the prime rate rises. During the draw period, you may only pay interest, so the payment increase is straightforward. During repayment, a rate increase raises both the interest and principal portions of your payment, which can be substantial.
Do I have to use the full HELOC amount?
No. You only borrow what you need and only pay interest on the amount you use. If you open a $50,000 HELOC but only draw $20,000, you pay interest only on that $20,000. You can leave the rest unused and available if an emergency arises.
Can I pay off a HELOC early without a penalty?
Most HELOCs allow early repayment without penalty, but some charge a fee if you close the account within a certain timeframe. Check your loan documents or ask the lender before you sign. Paying off early saves you interest, but you lose access to the credit line once it is closed.
What is the difference between the draw period and the repayment period?
During the draw period (usually 5 to 10 years), you can borrow and repay as many times as you want. During the repayment period (usually 10 to 20 years), you can no longer borrow — you can only pay down the balance. Your payment typically increases during repayment because you must pay principal as well as interest.