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

A HELOC — home equity line of credit — is a way to borrow money using your house as collateral. The lender gives you access to a sum of money based on how much equity you own in your home. Equity is the difference between what your home is worth and what you still owe on your mortgage. You can borrow from that line whenever you need it, up to your limit, and you pay interest only on the money you actually use.

A HELOC works differently from a traditional loan. Instead of receiving one lump sum upfront, you get a credit line — similar to a credit card — that you can draw from over time. This is called the draw period, which typically lasts 5 to 10 years. After the draw period ends, the repayment period begins, usually lasting 10 to 20 years, during which you can no longer borrow and must pay back what you owe.

Because your home secures the loan, HELOCs usually carry lower interest rates than credit cards or personal loans. However, this also means your home is at risk if you cannot repay the debt. The lender can foreclose — take your home — if you fall behind on payments.

Key Takeaways

  • A HELOC lets you borrow against the equity in your home and draw money as you need it, rather than receiving a lump sum all at once.
  • You pay interest only on the money you actually borrow, not on your full credit limit.
  • Interest rates on HELOCs are usually variable, meaning they can rise or fall over time based on market conditions.
  • Your home serves as collateral, so failure to repay can result in foreclosure.
  • The draw period (when you can borrow) and repayment period (when you pay back) are separate phases with different rules.

How lenders calculate your HELOC limit

Lenders determine how much you can borrow by looking at your home's current value and subtracting what you still owe on your mortgage. Most lenders will let you borrow 80 to 85 percent of your home's total equity, though some go higher or lower depending on their own policies and your credit history.

For example, if your home is worth $300,000 and you owe $200,000 on your mortgage, you have $100,000 in equity. A lender offering 80 percent of equity would give you a HELOC limit of $80,000. You would not have to use all of it — you could borrow $10,000 one month and $5,000 six months later.

Lenders also look at your credit score, income, and debt-to-income ratio before deciding whether to approve you and what interest rate to offer. A higher credit score usually means a lower rate.

Variable interest rates and payment changes

Most HELOCs have variable interest rates, which means your rate can change over time. The rate is usually tied to a benchmark rate set by the Federal Reserve, plus a margin the lender adds. When the benchmark rate rises, your rate rises with it, and your monthly payment increases. When it falls, your payment may decrease.

During the draw period, many HELOCs require only interest-only payments. This keeps your monthly cost low while you are borrowing, but it means you are not paying down the principal. Once the repayment period begins, your payment jumps because you now have to pay both principal and interest, and you can no longer borrow.

Some lenders offer fixed-rate HELOCs or the option to lock in a fixed rate on part of your balance. These cost more upfront but protect you from payment increases if interest rates rise.

When people use HELOCs and what they cost

Homeowners often use HELOCs to pay for home renovations, consolidate high-interest debt, cover medical bills, or fund education. Because you can draw money gradually, a HELOC works well for projects that happen over time, like a kitchen remodel that takes several months.

The cost of a HELOC varies widely. You may pay an application fee, an annual fee to keep the line open, and sometimes a closing cost similar to a mortgage. Interest rates range from around 4 to 12 percent depending on market conditions, your credit, and the lender — rates change frequently and vary by location and lender.

During the draw period, if you borrow $20,000 at 7 percent interest and make interest-only payments, you would pay roughly $140 per month. Once repayment begins, that payment rises sharply because you are now paying down the principal as well.

Risks of borrowing against your home

The biggest risk is that your home is collateral. If you miss payments or cannot repay the debt, the lender can foreclose and you could lose your home. This makes a HELOC riskier than an unsecured loan like a credit card, where the worst outcome is damage to your credit and collection action — not loss of your house.

Variable rates also create risk. If interest rates rise sharply, your payment could become unaffordable. Some borrowers take out a HELOC when rates are low, expecting to pay it back quickly, but then face a much higher payment when rates climb or when the repayment period begins.

A HELOC also ties up your home's equity, which means you cannot borrow against it again without paying off the line first. If you need cash in an emergency later, you may have fewer options.

HELOC vs. home equity loan: what is the difference

A home equity loan is different from a HELOC, though both use your home as collateral. A home equity loan gives you one lump sum upfront, which you repay on a fixed schedule with a fixed interest rate. You know exactly what your payment will be every month for the life of the loan.

A HELOC gives you a line of credit you draw from over time, usually with a variable rate and lower payments during the draw period. A home equity loan is simpler and more predictable; a HELOC is more flexible but riskier if rates rise.

If you need money all at once — say, to pay off a car loan — a home equity loan may be clearer. If you need to borrow gradually over time and want lower payments upfront, a HELOC may fit better. Both carry the risk of foreclosure if you cannot repay.

How to prepare before opening a HELOC

Before you approach a lender, know your home's approximate value. You can check recent sales of similar homes in your area, ask a real estate agent, or order an appraisal. Subtract what you owe on your mortgage to find your equity.

Check your credit report and credit score. You can get a free credit report once per year from annualcreditreport.com. A higher score will help you get approved and receive a better rate. If your score is low, you may want to pay down other debts or wait before applying.

Gather recent pay stubs, tax returns, and bank statements. Lenders will ask for proof of income and assets. Shop around with at least three lenders — rates and fees vary significantly, and a difference of even half a percent can save you thousands over the life of the line.

Frequently Asked Questions

Can I use a HELOC to pay off credit card debt?

Yes. Because HELOC rates are usually lower than credit card rates, many people use them to consolidate high-interest debt. However, this only saves money if you do not run up the credit cards again and if you can afford the HELOC payment when the repayment period begins and rates may have risen.

What happens to my HELOC if I sell my house?

You must pay off the HELOC balance in full when you sell. The lender's claim on your home is satisfied from the sale proceeds before you receive any money. If you still owe more than the home sells for, you remain responsible for the difference.

Can I get a HELOC if I have bad credit?

It is harder but sometimes possible. Some lenders work with borrowers who have lower credit scores, but they charge higher interest rates and may require a larger down payment or lower loan-to-value ratio. Shopping with multiple lenders increases your chances of finding one willing to work with you.

What is the difference between a draw period and a repayment period?

During the draw period (typically 5 to 10 years), you can borrow and usually pay interest only. During the repayment period (typically 10 to 20 years), you cannot borrow anymore and must pay back the full balance with principal and interest. Your payment rises significantly when you move from draw to repayment.

Do I have to use my entire HELOC limit?

No. You borrow only what you need and pay interest only on what you use. However, some lenders charge an annual fee to keep the line open even if you do not use it, so check the terms before you open one.