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

A HELOC (home equity line of credit) is a loan where the lender gives you access to money based on how much your home is worth minus what you still owe on your mortgage. You don't borrow all the money at once. Instead, you get a credit limit — say $50,000 — and you can borrow from it whenever you need to, up to that limit, during a set period called the draw period. The lender holds the right to your home as collateral, which is why the interest rate is usually lower than a credit card or personal loan.

The money comes from the equity you've built in your home. If your house is worth $300,000 and you owe $200,000 on your mortgage, you have $100,000 in equity. Most lenders will let you borrow 80 to 90 percent of that equity, though the exact amount depends on your credit score, income, and how stable the lender thinks your home's value is.

Key Takeaways

  • A HELOC lets you borrow money using your home as collateral, and you only pay interest on the money you actually use, not the full credit limit.
  • The draw period (usually 5 to 10 years) is when you can borrow; the repayment period (usually 10 to 20 years) is when you pay it back, often with a higher payment once the draw period ends.
  • Interest rates on HELOCs are variable, meaning they go up or down with the market, so your monthly payment can change.
  • If you stop paying a HELOC, the lender can foreclose on your home, just as with a mortgage.
  • You will need recent pay stubs, tax returns, bank statements, and a current home appraisal or assessment to open a HELOC.

How the draw period and repayment period work

A HELOC has two phases. During the draw period — typically 5 to 10 years — you can borrow money whenever you want by writing a check, using a debit card, or requesting a transfer. You only pay interest on what you've borrowed, not on the full credit limit. Many people pay only interest during this phase, so their monthly payment is low.

Once the draw period ends, the repayment period begins, usually lasting 10 to 20 years. Now you can no longer borrow new money. You must pay back everything you borrowed, plus interest, on a fixed schedule. Your monthly payment jumps significantly because you're now repaying principal, not just interest. Some HELOCs require you to pay back the entire balance in one lump sum at the end of the draw period, which is rare but possible — read the terms carefully.

This two-phase structure is why a HELOC can be risky. Borrowers sometimes take out a HELOC, use it during the draw period, and then face a payment shock when repayment begins. If you can't afford the new payment, you're at risk of losing your home.

Interest rates and how payments change

HELOC interest rates are variable, not fixed. They're tied to a market index (usually the prime rate) plus a margin the lender adds. When the prime rate rises, your interest 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.

Most HELOCs have a rate cap — a maximum interest rate you'll ever pay — but that cap is often 8 to 12 percent, which is still much higher than current mortgage rates. During the draw period, you might pay 6 percent. Once repayment starts and rates have risen, you could be paying 9 or 10 percent on a much larger monthly payment.

Some lenders offer a fixed-rate option on part of your HELOC balance, which locks in the rate on that portion. This costs more upfront but removes the uncertainty. Ask whether your lender offers this before you sign.

What documents you need to open a HELOC

Lenders require proof of income, assets, and home value. Bring recent pay stubs (usually the last two months), tax returns (usually the last two years), and bank statements showing you have savings. You'll also need your mortgage statement to confirm how much you owe.

The lender will order an appraisal or use an automated valuation to determine your home's current worth. This costs $300 to $600 and is sometimes paid by the lender, sometimes by you. If your home's value has dropped since you bought it, you may not be able to borrow as much as you expected, or you may not may have access to at all.

You'll also need to provide identification, proof of homeownership (deed or title), and authorization for the lender to pull your credit report. The whole process typically takes 2 to 4 weeks from application to funding.

Costs beyond the interest rate

Opening a HELOC involves fees. Origination fees (1 to 3 percent of the credit limit) cover the lender's processing costs. Appraisal fees run $300 to $600. Some lenders charge annual fees ($50 to $100) just to keep the account open, even if you don't use it. A few charge inactivity fees if you don't borrow within a certain period.

There may also be closing costs similar to a mortgage: title search, title insurance, recording fees, and attorney fees if your state requires it. These can total $1,000 to $3,000. Some lenders waive certain fees to compete for your business, so shop around.

If you close the HELOC before the draw period ends, some lenders charge an early termination fee. Read the fine print before you sign.

Why a HELOC is risky if you can't repay

A HELOC is secured by your home. If you stop paying, the lender can foreclose — meaning they take your house and sell it to recover what you owe. This is the same consequence as defaulting on a mortgage, and it's much more serious than missing a credit card payment.

The risk is especially high during the repayment phase, when your payment jumps. If you borrowed $40,000 during the draw period and your payment was $200 a month (interest only), it might become $600 or $700 a month once repayment starts. If your income drops or expenses rise, you could find yourself unable to pay and facing foreclosure on a home you've owned for years.

This is why financial advisors often warn against using a HELOC for discretionary spending — vacations, cars, or home renovations that don't increase your home's value. If you use it to consolidate high-interest debt or make repairs that protect your home's value, the risk is more justified.

HELOC vs. home equity loan: the main difference

A home equity loan is different from a HELOC, though both use your home as collateral. With a home equity loan, you borrow a lump sum all at once and repay it on a fixed schedule with a fixed interest rate. Your payment never changes. With a HELOC, you borrow as you need it, pay variable interest, and face a payment shock when the draw period ends.

A home equity loan is simpler and more predictable. A HELOC is more flexible during the draw period but riskier overall. If you know exactly how much you need and want certainty about your payment, a home equity loan may be the better choice. If you want to borrow gradually and aren't sure of the total amount, a HELOC offers that flexibility — but only if you can handle the payment increase later.

Frequently Asked Questions

Can I use a HELOC for anything I want?

Legally, yes — once the money is in your account, you can spend it on anything. But using it for high-risk purposes (like gambling or speculative investments) is unwise because you're putting your home at risk. Most people use HELOCs for debt consolidation, home repairs, education, or medical expenses.

What happens to my HELOC if my home's value drops?

If your home loses value, the lender may reduce your credit limit or freeze your account so you can't borrow more. They may also require you to pay down the balance. This happened to many homeowners during the 2008 housing crisis. Your existing balance doesn't disappear, but your access to new credit does.

Can I pay off a HELOC early?

Yes, you can pay off the balance at any time. Some lenders charge an early termination fee if you close the account during the draw period, but not all do. Check your agreement before you sign. Paying it off early saves you interest but means you lose access to that credit line.

What credit score do I need for a HELOC?

Most lenders require a credit score of at least 620, but competitive rates usually start at 680 or higher. The higher your score, the lower your interest rate. If your score is below 620, you may not be able to open a HELOC at all, or you'll pay a much higher rate.

What if I can't afford the payment when the draw period ends?

Contact your lender immediately. Some lenders will extend the draw period or restructure the repayment terms, though this usually means paying more interest overall. Others won't negotiate. If you can't reach an agreement, you may need to refinance the HELOC into a different loan or sell the home. Ignoring the problem leads to foreclosure.