A HELOC is a line of credit secured by your home's value

A HELOC (home equity line of credit) lets you borrow money using the equity you have built in your home. The lender gives you access to a credit line — similar to a credit card — and you can draw from it as you need it, up to a limit. You only pay interest on the money you actually borrow, not on the full credit line.

The key difference from a traditional home loan is flexibility. With a mortgage, you get a lump sum upfront. With a HELOC, you draw money when you need it, repay it, and can borrow again during the "draw period" — typically 5 to 10 years. After that period ends, the HELOC moves into a "repayment period" where you can no longer borrow and must pay back what you owe, usually over 10 to 20 years.

Your home serves as collateral, which is why interest rates on HELOCs are usually lower than credit cards or personal loans. If you stop making payments, the lender can foreclose on your home.

Key Takeaways

  • A HELOC is a revolving credit line backed by your home's equity, and you pay interest only on what you borrow.
  • The draw period (when you can borrow) typically lasts 5 to 10 years, followed by a repayment period of 10 to 20 years when you cannot borrow anymore.
  • Interest rates on HELOCs are usually variable, meaning your monthly payment can increase or decrease based on market conditions.
  • Your home is collateral, so failure to repay can result in foreclosure.
  • You need enough equity in your home to open a HELOC, and lenders typically require you to keep some equity untouched.

How much equity you need and how much you can borrow

To open a HELOC, you must have built equity in your home — the difference between what your home is worth and what you still owe on your mortgage. Most lenders require you to have at least 15 to 20 percent equity before they will offer a HELOC.

The amount you can borrow depends on your equity and the lender's policy. Many lenders let you borrow up to 80 or 85 percent of your home's total value, minus what you still owe on your mortgage. 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 LTV (loan-to-value) might let you borrow up to $40,000 through a HELOC.

Lenders also look at your credit score, income, and debt-to-income ratio. A higher credit score and lower existing debt usually mean a higher credit line and better interest rate.

Interest rates and how payments work during the draw period

Most HELOCs have variable interest rates, which means the rate changes over time based on a benchmark rate set by the Federal Reserve. Your rate is typically the benchmark rate plus a margin set by your lender. When the benchmark rises, your rate and monthly payment rise with it.

During the draw period, you usually have the option to make interest-only payments. This keeps your monthly cost low while you are borrowing. However, you are not paying down the principal (the amount you borrowed), so the debt does not shrink. Some borrowers make interest-only payments during the draw period and then face a payment shock when the repayment period begins and they must pay both principal and interest.

A few lenders offer fixed-rate HELOCs, where the interest rate stays the same for the life of the loan. These are less common and usually come with a higher starting rate than variable options, but they protect you from payment increases.

What happens when the draw period ends

When your draw period ends — typically after 5 to 10 years — you enter the repayment period. At this point, you can no longer borrow from the credit line. You must begin paying back the full balance, including principal and interest, usually over 10 to 20 years.

This transition can be expensive. If you made only interest-only payments during the draw period, your monthly payment can double or triple once repayment begins. For example, a $50,000 HELOC at 7 percent interest costs about $292 per month in interest-only payments. When repayment starts over 15 years, the payment jumps to roughly $467 per month.

Some borrowers refinance their HELOC into a new one or a fixed-rate loan to avoid this payment shock. Others plan ahead by making principal payments during the draw period to reduce the balance before repayment begins.

Costs and fees associated with opening a HELOC

Opening a HELOC involves upfront costs similar to a mortgage. You will typically pay for an appraisal (to determine your home's value), a credit report, title search, and closing costs. These fees range from $500 to $2,000 depending on your lender and location.

Some lenders waive closing costs to attract borrowers, but this is less common than with mortgages. You may also face an annual fee (usually $25 to $100) just to keep the credit line open, even if you do not borrow anything.

If you draw money and then pay it back before the draw period ends, there are no prepayment penalties on most HELOCs. However, some lenders charge a fee if you close the account early or if you do not use the credit line within a certain period.

HELOC vs. home equity loan: which is different

A home equity loan is different from a HELOC, though both use your home as collateral. With a home equity loan, you receive a lump sum upfront and repay it in fixed monthly payments over a set term (usually 5 to 15 years). The interest rate is typically fixed, so your payment never changes.

A HELOC is more flexible — you draw money as needed and pay interest only on what you borrow. But that flexibility comes with variable rates and the risk of payment shock when the draw period ends. A home equity loan is simpler and more predictable but less flexible if you need money at different times.

Choose a HELOC if you need access to money over time (for renovations, education, or unexpected expenses). Choose a home equity loan if you need a specific amount now and want a predictable, fixed payment.

Risks and when a HELOC can go wrong

The biggest risk is that your home is collateral. If you cannot make payments, the lender can foreclose and you can lose your home. This makes a HELOC riskier than an unsecured loan like a credit card, even though the interest rate is lower.

Variable interest rates create another risk. If rates rise significantly, your monthly payment can become unaffordable. During the 2008 financial crisis, many borrowers faced payment increases they could not manage when their HELOCs adjusted.

A third risk is overborrowing. Because a HELOC feels like free-floating credit, it is easy to borrow more than you can repay. If your home's value drops (as it did in 2008), you could owe more than your home is worth and be unable to refinance or sell without taking a loss.

Frequently Asked Questions

Can I use a HELOC for anything I want?

Yes. Once you have the money, you can use it for home repairs, debt consolidation, education, medical expenses, or any other purpose. Lenders do not restrict how you spend the money, though some may ask what you plan to use it for during the application process.

What is the difference between a HELOC and a credit card?

Both are revolving credit, but a HELOC is secured by your home and has a lower interest rate. A credit card is unsecured and has a much higher rate. A HELOC also typically has a higher credit limit and a longer draw period, but missing payments puts your home at risk.

Can I get a HELOC if I have bad credit?

It is harder but possible. Most lenders require a credit score of at least 620, though 700 or higher gets better rates. If your score is lower, you may find lenders willing to work with you, but you will pay a higher interest rate and may have a smaller credit line.

What happens if interest rates drop after I open a HELOC?

Your rate will drop automatically because it is tied to a benchmark rate. Your monthly payment will decrease. This is one advantage of a variable-rate HELOC when rates are falling, though the opposite happens when rates rise.

Can I pay off my HELOC early without a penalty?

Most HELOCs have no prepayment penalty, so you can pay off the balance whenever you want. However, some lenders charge a fee if you close the account within a certain period (often 3 to 5 years). Read your agreement to confirm.