A HELOC is a line of credit you borrow against using your home as collateral

A HELOC (home equity line of credit) lets you borrow money in smaller amounts over time, rather than getting one lump sum like a traditional loan. The lender gives you access to a credit line — say $50,000 — and you draw from it when you need cash. You only pay interest on the money you actually borrow, not the full amount available to you.

The lender secures the HELOC against your home's equity — the difference between what your house is worth and what you still owe on your mortgage. If you stop paying, the lender can foreclose and sell your home to recover the debt. This is why HELOC interest rates are usually lower than credit card rates: the lender's risk is smaller because they have a claim on your property.

HELOCs work in two phases. During the draw period — typically 5 to 10 years — you can borrow and repay as often as you want, like a credit card. After the draw period ends, the repayment period begins, usually lasting 10 to 20 years. At that point you can no longer borrow new money; you can only pay down what you owe.

Key Takeaways

  • You borrow only what you need during the draw period and pay interest only on that amount, making a HELOC cheaper than credit cards for large expenses.
  • Your home secures the debt, so the lender can foreclose if you fall behind on payments.
  • Interest rates on HELOCs are usually variable, meaning your monthly payment can rise if rates go up.
  • When the draw period ends, you lose the ability to borrow more and must begin repaying the full balance over the repayment period.
  • You need significant home equity — usually at least 15 to 20 percent — to open a HELOC, and lenders will order an appraisal.

How the draw period and repayment period work

During the draw period, you access your credit line whenever you need it. You might borrow $10,000 in month one, pay back $3,000 in month three, then borrow another $8,000 in month six. Your monthly payment during this phase is often interest-only, meaning you pay what you owe in interest but do not reduce the principal balance. Some HELOCs require you to pay both interest and principal during the draw period; check your agreement to know which applies to yours.

When the draw period ends — say, after 7 years — the repayment period begins. You can no longer borrow against the line. If you still owe $35,000, you now have 15 years to pay it back in full. Your monthly payment jumps because you are now paying both principal and interest, and the payment is fixed for the rest of the loan term. This is when many borrowers face payment shock: a payment that was $200 a month during the draw period might become $350 or more.

Some HELOCs allow you to convert your balance to a fixed-rate loan before the repayment period starts. This locks in your interest rate and can make your payment more predictable, but it usually costs a fee and the rate may be higher than your current variable rate.

Interest rates and how they change

Most HELOCs have variable interest rates tied to a market index — usually the prime rate. When the Federal Reserve raises or lowers rates, your HELOC rate moves with it, usually within 30 to 45 days. If rates rise, your monthly payment rises. If rates fall, your payment falls. This is different from a fixed-rate mortgage, where your rate never changes.

Your actual rate is the index rate plus a margin set by your lender — typically 1 to 3 percentage points. If the prime rate is 7 percent and your margin is 2 percent, your rate is 9 percent. When the prime rate moves to 7.5 percent, your rate becomes 9.5 percent.

Most HELOCs have a rate cap — a ceiling above which your rate cannot rise, even if the index soars. A common cap is 18 percent. Some also have a floor, a minimum rate you pay even if the index drops below it. Read your agreement to find both numbers. During periods of rising rates, your payment can increase significantly, so budget for the possibility that your monthly cost will go up.

What you need to open a HELOC

Lenders require you to have built up home equity before they will open a HELOC. Most want to see at least 15 to 20 percent equity in your home. If your house is worth $300,000 and you owe $240,000 on your mortgage, you have $60,000 in equity — 20 percent. You could potentially borrow up to $30,000 or $40,000 on a HELOC, depending on the lender's policies.

The lender will order a professional appraisal of your home to confirm its current value. They will also pull your credit report and verify your income and employment. You will need to provide recent pay stubs, tax returns, and bank statements. The process typically takes 2 to 4 weeks from application to approval.

Your credit score matters. Most lenders want a score of at least 650 to 680, though some will work with lower scores at a higher rate. If you have recent late payments, foreclosure, or bankruptcy, you may not be approved, or approval may come with a significantly higher rate.

Costs and fees associated with a HELOC

Opening a HELOC involves several costs. An appraisal fee typically runs $300 to $600. You may pay an application fee of $100 to $300, though some lenders waive this. Title search and insurance can cost $200 to $400. Some lenders charge an origination fee of 1 to 3 percent of the credit line amount — on a $50,000 line, that could be $500 to $1,500.

Once the HELOC is open, you may face an annual fee of $50 to $100 just to keep the account active, though many lenders have dropped this. If you do not use the line for a certain period — often 12 months — some lenders charge an inactivity fee. If you close the account early, you might owe a prepayment penalty, though these are less common than they once were.

During the draw period, you typically pay only interest, so your monthly cost is lower than during repayment. But do not mistake a low payment for a low cost. If you borrow $40,000 at 8 percent interest during a 7-year draw period and pay only interest, you will pay roughly $2,240 per year in interest alone — and you still owe the full $40,000 when the draw period ends.

HELOC versus home equity loan: the key differences

A home equity loan is different from a HELOC, though both use your home as collateral. With a home equity loan, you receive the full amount upfront as a lump sum. You cannot borrow more later. Your interest rate is fixed for the entire loan term, so your payment never changes. You repay the loan in equal monthly payments over a set period, usually 5 to 15 years.

A HELOC gives you flexibility: you borrow only what you need, when you need it, and you can borrow again after you repay. But that flexibility comes with a variable rate, which means your payment can rise. A home equity loan is simpler and more predictable if you know exactly how much you need and want a payment that never changes.

Choose a HELOC if you have ongoing expenses — home renovation, medical bills, or business costs — that you will pay over time. Choose a home equity loan if you need one large amount for a single purpose and want payment certainty.

Risks of borrowing against your home

The biggest risk is foreclosure. If you cannot pay your HELOC, the lender can foreclose on your home and sell it to recover the debt. This is a real consequence, not a theoretical one. Unlike credit card debt, which does not put your housing at risk, a HELOC puts your home itself on the line.

Rising interest rates are another risk. If you borrow $30,000 at 6 percent during the draw period and rates rise to 10 percent by the time repayment begins, your monthly payment will be much higher than you planned. A payment that was $150 a month in interest-only mode might become $400 or more once you are paying principal and interest at the higher rate.

Some borrowers use a HELOC to pay off credit card debt, which can backfire. You have traded unsecured debt (credit cards) for secured debt (HELOC). If you then run up the credit cards again, you now owe both, and your home is still at risk. The HELOC did not solve the underlying spending problem.

Frequently Asked Questions

Can I use a HELOC for anything I want?

Yes, legally you can use HELOC funds for any purpose — home renovation, debt consolidation, education, medical bills, or business expenses. Some lenders ask what you plan to use the money for, but they cannot legally restrict how you spend it once the funds are in your account. However, using a HELOC to pay off credit card debt only works if you stop accumulating new credit card debt.

What happens to my HELOC if my home value drops?

If your home loses value, your equity shrinks. If you owe $240,000 on your mortgage and your home drops from $300,000 to $250,000 in value, your equity is now only $10,000. The lender may freeze your HELOC, preventing you from borrowing more, or reduce your credit line. You still owe what you have already borrowed, but you cannot access additional funds.

Can I have both a mortgage and a HELOC at the same time?

Yes. The HELOC is a second lien on your home, sitting behind your mortgage. If you default on both, the mortgage lender gets paid first from the sale proceeds, and the HELOC lender gets whatever is left. This is why HELOC rates are higher than mortgage rates — the lender's risk is greater.

What if I cannot pay during the repayment period?

Contact your lender immediately. Some offer forbearance, temporarily lowering or pausing your payment. Others may allow you to extend the repayment period, which lowers your monthly payment but increases the total interest you pay. If you do not contact them, missed payments will damage your credit and can lead to foreclosure.

Is the interest on a HELOC tax-deductible?

Interest on a HELOC used to improve your home may be tax-deductible if you itemize deductions on your federal tax return, but the rules are complex and changed in 2017. Interest on a HELOC used for other purposes is generally not deductible. Consult a tax professional about your specific situation before relying on any deduction.