A HELOC is a loan against the equity you have built in your home

A home equity line of credit, or HELOC, is a way to borrow money using your house as collateral. The lender looks at how much your home is worth, subtracts what you still owe on your mortgage, and lets you borrow against that difference — called your equity. Unlike a mortgage, which you receive as one lump sum, a HELOC works like a credit card: you have a credit limit, and you draw money only when you need it.

The lender holds a second mortgage on your home, meaning if you stop paying, they can foreclose. This is why HELOCs typically have lower interest rates than credit cards or personal loans — the lender's risk is lower because they have a claim on your property.

HELOCs come in two phases. During the draw period, usually 5 to 10 years, you can borrow and repay repeatedly, like a credit card. During the repayment period, usually 10 to 20 years, you can no longer draw new money and must pay back what you borrowed, plus interest.

Key Takeaways

  • A HELOC lets you borrow money based on the equity in your home, and you pay interest only on the amount you actually use.
  • The interest rate on a HELOC is usually variable, meaning it changes with market rates, so your monthly payment can go up or down over time.
  • You must own your home and have built up equity — typically at least 15 to 20 percent of the home's value — to open a HELOC.
  • If you fail to repay a HELOC, the lender can foreclose on your home, so this is a secured debt that carries real risk.
  • The draw period and repayment period have different rules: during the draw period you can borrow more, but during repayment you can only pay back what you owe.

How much you can borrow depends on your home's value and what you owe

Lenders calculate your available credit by taking your home's current market value, subtracting your mortgage balance, and then lending you a percentage of that equity — usually 75 to 85 percent. If your home is worth $300,000 and you owe $200,000 on your mortgage, your equity is $100,000. A lender might offer you a HELOC of $75,000 to $85,000.

The exact amount depends on the lender's policies, your credit score, your income, and your debt-to-income ratio. Lenders want to see that you can afford the payments. A home appraisal is usually required, and the process typically takes two to four weeks.

You do not have to use the full credit limit. If you open a $75,000 HELOC and draw only $20,000, you pay interest only on that $20,000. As you repay it, that money becomes available to borrow again — similar to how a credit card works.

Interest rates on HELOCs are usually variable, not fixed

Most HELOCs have a variable interest rate, which means the rate changes periodically based on a benchmark rate set by the Federal Reserve. When the benchmark rises, your rate rises and your monthly payment goes up. When it falls, your payment goes down. This is different from a fixed-rate mortgage, where your rate and payment stay the same for 30 years.

Some lenders offer a fixed-rate option for part or all of the HELOC, but this is less common and usually comes with a higher starting rate. Variable rates are attractive when interest rates are falling or stable, but they create uncertainty if rates climb sharply.

During the draw period, many HELOCs require only interest-only payments, so your monthly bill is lower. Once the repayment period begins, you must pay both principal and interest, and your payment typically increases significantly — even if the interest rate stays the same.

What you need to open a HELOC

To open a HELOC, you must own your home and have built substantial equity. Most lenders require at least 15 to 20 percent equity, though some will go lower. You will need to provide proof of income, recent tax returns, bank statements, and a current mortgage statement showing your balance. The lender will order a home appraisal to confirm the property value.

Your credit score matters. Most lenders want a score of 650 or higher, though some require 700 or better. Your debt-to-income ratio — the total of all your monthly debt payments divided by your gross monthly income — is also reviewed. Lenders typically want this ratio below 43 percent.

The application process is similar to a mortgage application. You will sign disclosure documents explaining the terms, the variable rate structure, and what happens when the draw period ends. Read these carefully, because they contain the rules that will govern your account for years.

Common reasons people use a HELOC

HELOCs are often used for home renovations, because you can draw money as the work progresses and pay interest only on what you have spent. They are also used to consolidate high-interest debt like credit cards, since HELOC rates are typically lower. Some people use them as an emergency fund, keeping the credit line open but unused until they need it.

Because the interest on a HELOC may be tax-deductible if the money is used to improve the home, some homeowners use them for that purpose specifically. However, tax rules are complex and depend on how you use the money, so consult a tax professional before assuming your interest is deductible.

HELOCs are less commonly used for everyday expenses or to fund investments, because the variable rate and the risk of foreclosure make them expensive and risky for those purposes.

The risks of a HELOC

The biggest risk is foreclosure. If you cannot make your payments, the lender can force the sale of your home to recover what you owe. This is different from credit card debt, where the worst outcome is a damaged credit score and lawsuits — your home is not at stake.

A second risk is payment shock. When the draw period ends and the repayment period begins, your monthly payment can jump sharply. If you have been paying interest-only for 10 years, the switch to principal-plus-interest payments can double or triple your bill. If interest rates have also risen, the shock is even larger.

Variable rates create uncertainty. If you budget based on today's rate and rates climb, your payment will rise. Over a 20-year repayment period, a significant rate increase can cost you tens of thousands of dollars in additional interest.

Some HELOCs have a balloon payment at the end, meaning a large lump sum is due on the final day. Read your agreement carefully to see whether yours does.

How a HELOC differs from a home equity loan

A home equity loan is similar to a HELOC but works differently. With a home equity loan, you receive the full borrowed amount upfront as a lump sum, and you repay it over a fixed term — usually 5 to 15 years — at a fixed interest rate. Your payment is the same every month.

A HELOC, by contrast, lets you borrow only what you need, when you need it, and your rate is usually variable. A home equity loan is simpler if you know exactly how much you need and want a predictable payment. A HELOC is more flexible if you need money over time or want to keep a reserve available.

Home equity loans are also called second mortgages, as are HELOCs — both put a lien on your home. The main difference is the structure: a loan is a one-time draw with fixed payments, while a line of credit is a revolving account with variable payments.

Frequently Asked Questions

Can I lose my home if I don't pay back a HELOC?

Yes. A HELOC is secured by your home, meaning the lender has the legal right to foreclose if you default. This makes a HELOC riskier than unsecured debt like credit cards, where the worst outcome is a damaged credit score and collection efforts.

What happens when the draw period ends?

When the draw period ends, you enter the repayment period and can no longer borrow new money. Your monthly payment changes from interest-only to principal-plus-interest, which is usually much higher. Some HELOCs require the full balance to be paid off by the end of the repayment period, while others convert to a fixed-rate loan.

Can I pay off a HELOC early?

Yes, most HELOCs allow early repayment without penalty. Paying off early saves you interest and reduces your risk. Check your agreement to confirm there is no prepayment penalty, though these are uncommon on HELOCs.

What if my home's value drops?

If your home loses value, your equity shrinks. Some lenders will freeze or reduce your credit limit. If you owe more than the home is worth, you cannot borrow more, and you may face difficulty selling or refinancing.

Is the interest on a HELOC tax-deductible?

Interest may be deductible if you use the HELOC to buy, build, or improve your home. Interest on a HELOC used for other purposes is not deductible. Tax rules are detailed and depend on your specific situation, so consult a tax professional before relying on a deduction.