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Thanks to elevated home prices, many homeowners have found themselves with an unexpected boost in their home equity in recent years. That creates an opportunity to borrow with a home equity line of credit (HELOC).
A second home loan is a big commitment, but as a credit line, a HELOC offers a lot of flexibility. In fact, you don't even have to borrow any money immediately after you get a HELOC; you can just keep the line open until you're ready to tap it. And when you do borrow, you'll have a lot of options for how to use and repay those funds.
Still, whether you'll be approved for a HELOC will depend on your home’s value, mortgage balance, debt-to-income ratio, and credit score, among other factors. Are you considering tapping your home equity using a HELOC? Here’s what you need to know.
Dig deeper: How to determine your home value
In this article:
What is a HELOC, and how does it work?
A HELOC is a type of second mortgage that is a revolving credit line secured by your home equity. Your home equity is the difference between your home's value and your mortgage balance — or the portion of the house that you actually own.
With a HELOC, you can turn a portion of your home equity into a line of credit, withdrawing as much or as little as you want up to your credit limit. You can then repay — and reborrow — from the HELOC, much like a credit card, until the HELOC’s draw period is up.
Draw periods usually last 10 years, and during that time, you’ll typically make interest-only payments based on the amount you’ve withdrawn. This is one advantage unique to HELOCs compared to other home equity options: You'll only be charged interest on the amounts you borrow — not the entire credit line. Keep in mind, though: Most HELOCs have a variable interest rate, which can go up or down depending on various economic factors. This means your monthly costs can fluctuate, too.
Once the draw period is up, you enter the repayment period, which is when you’ll make full interest and principal payments. This period is typically 10 to 20 years, though it depends on your lender.
Tip: Although HELOCS typically have adjustable rates, some HELOCs allow you to lock in a fixed rate for all or a portion of your balance during your draw period. With this option, you can set up a repayment schedule and eliminate the risk of a higher rate on that portion of your debt while you continue to have access to draw any remaining funds up to your credit limit.
Learn more: The best HELOC lenders right now
How to get a HELOC
To be eligible for a home equity line of credit, you'll need at least 15% to 20% equity in your home, depending on the lender. In addition, most mortgage lenders require a 680 credit score, a 43% debt-to-income ratio (DTI), and proof of income and homeowners insurance.
Once you've prepared your finances, choose a HELOC lender and gather the necessary documentation, such as a recent mortgage statement, your last two tax returns and W-2s, and a government-issued ID. You'll fill out the lender's application and go through the underwriting process, and the lender will likely require an appraisal. This is used to confirm your home’s market value and, thus, how much equity you have in the property (and can borrow from). You’ll then close on the HELOC and get access to your money.
Read more: How to get a HELOC in 6 simple steps
How to repay your HELOC
What is a HELOC ‘draw’ period?
Most HELOCs have a "draw" period, during which you can borrow and, if you choose to, repay and re-borrow additional funds repeatedly. Borrowing may be as easy as writing a check or swiping a credit card linked to your HELOC. You also might be able to transfer funds from your HELOC to a checking or savings account.
The draw period on HELOCs is typically 10 years. At the end of your draw period, your lender may allow you to refinance your HELOC into a new credit line or another type of loan.
Learn more: HELOC draw period — How long it lasts and how payments work
What is a HELOC ‘repayment’ period?
If you don't refinance, you'll have to pay off your balance, including principal and interest charges, during the “repayment” period. Repayment may be due immediately or over a fixed repayment term, depending on the terms of your HELOC agreement.
If you sell your home during either your draw or repayment period, you'll typically have to pay off your HELOC with the proceeds from the home sale.
Types of HELOCs
Interest-only HELOCs
Interest-only HELOCs are probably the most common type of HELOC right now. With this option, you only pay back the interest on the money you withdraw during the draw period. Once your draw period ends and the repayment period begins, your monthly payments will go toward both interest and principal.
Interest-only payments can make HELOCs affordable for the length of your draw period. Just make sure you're prepared for monthly payments to increase once it's time to pay back the principal. (And for those payments to fluctuate if you have a variable interest rate.)
Learn more: Interest-only HELOC — How payments are calculated
Fixed-rate HELOCs
HELOCs typically come with variable interest rates, but some mortgage lenders offer the option to transfer some or all of your HELOC balance to a fixed-rate loan.
With a fixed-rate HELOC, you choose how much of your withdrawn amount you want to transfer into a fixed-rate loan. Then, you make monthly payments toward that loan along with your regular payments toward the line of credit. Many lenders let you lock in a rate multiple times throughout your term, but you may have to pay a fee each time.
Dig deeper: How do fixed-rate HELOCs work, and which lenders offer them?
Pros and cons of a HELOC
By tapping into your home equity with a HELOC, you are taking out a second mortgage. This strategy has pros and cons, so make sure you’ve done your research before diving in.
Here’s what you should think about:
Pros
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Tap into your home equity without affecting your original mortgage term or rate
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Use the money however you see fit, from home improvements to paying off student loans or credit card debt
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You can borrow, repay, and re-borrow as many times as you like across the draw period
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If you have a variable interest rate, your rate and payment could fall if market rates decrease
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You only pay interest on what you withdraw — not the entire credit line
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You'll usually only make interest-only payments during the draw period, keeping your payments low at the outset
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Interest payments may be tax deductible if you use the money to improve your home
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Interest rates are typically lower than rates offered on personal loans and credit cards
Cons
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You'll have two monthly home loan payments, not just one
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A variable interest rate means your rate and payment could rise if market rates increase
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Your home is collateral for paying off your HELOC, which means there is a risk of foreclosure if you don't make payments
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Monthly payments will increase when you enter the repayment period, which switches you from interest-only payments to principal-plus-interest payments
Read more: 4 types of home renovation loans and how to choose
How to refinance a HELOC
Refinancing a HELOC could be in your best interest, especially if the draw period is ending and you've realized you can't afford the higher monthly payments that will come with the repayment period.
Here are your options for refinancing a line of credit:
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Loan modification: This isn't technically a type of refinance, but it is among the options you should consider. With a loan modification, you ask the lender to alter the terms of your HELOC to extend your draw or repayment period, change your interest rate, or increase your credit limit. Your lender might say no, but it's worth asking before looking into refinancing. It’s typically only an option if you’re having financial difficulties.
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Cash-out refinance: This is a good choice if you want to replace your original mortgage with a new one. You can use the excess funds from the cash-out refi to pay off your outstanding HELOC and mortgage balances, essentially combining them into one loan and one monthly payment.
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Apply for a new HELOC: You can get a new home equity line of credit and use the money to pay off the balance on your old one. Of course, then you'll have to go through the HELOC withdrawal/repayment process all over again — but this delays your repayment period and gives you time to financially prepare to pay off your principal the second time around.
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Get a home equity loan: With a home equity loan, you'll receive the money in one lump sum rather than as a line of credit. You can use that money to pay off your HELOC balance, then make monthly payments to pay off your home equity loan. This could be a good choice if you've improved your credit score and DTI ratio so you can land a good fixed interest rate.
Remember, all of the above options require you to pay closing costs, with the exception of loan modification.
Dig deeper: Yes, you can refinance a HELOC — Here's how
HELOC interest rates
With HELOCs, you’ll only pay interest on the money you withdraw. Most also require interest-only payments during the draw period, allowing you to keep your monthly costs low for the first decade or more.
Once you enter repayment, you’ll usually make full principal and interest payments for the remaining months of the term. If you have a variable interest rate, those payments could increase or decrease depending on where market rates move. (There may be a cap, though, which protects you from rates rising too much in a single year or across your HELOC’s term.)
Generally speaking, HELOC interest rates tend to be slightly higher than the rate you’d get on a first-lien mortgage. They have lower interest rates than products like personal loans and credit cards, though. So, HELOCs are good options for accessing money with a relatively low interest rate, especially if you don’t want to replace your original mortgage.
Is HELOC interest tax deductible?
Sometimes. You can deduct interest paid on your HELOC if you itemize your deductions when you file taxes and you use the money to "buy, build, or substantially improve” your house, according to the IRS. HELOC interest is not tax deductible if you take the standard deduction.
The current rule is that you can deduct interest paid on up to $750,000 of mortgage debt or $375,000 if you're married and filing separately. This limit applies to primary and secondary mortgages combined. For example, you can claim interest paid on $750,000 of your primary mortgage, HELOC, and home equity loan in total.
Learn more: How to deduct interest paid on a HELOC
HELOC alternatives
If you're curious about alternatives to a HELOC, you may want to explore a cash-out refinance, home equity loan, personal loan or personal line of credit, or reverse mortgage, among other options.
Cash-out refinance
A cash-out refinance replaces your current home mortgage with a new mortgage that has a higher balance. A portion of your new loan is used to pay off your existing loan. The remainder, after closing costs are paid, is provided to you in a lump sum.
Read more: Cash-out refinance vs. HELOC
Home equity loan
A home equity loan is another type of second mortgage that allows you to borrow from your home equity. Unlike a HELOC, though, it comes with a lump sum payment you’ll receive right after closing. This type of loan typically has a fixed rate and fixed monthly payment.
Dig deeper: HELOC vs. home equity loan
Personal loan
A personal loan or line of credit is an option not secured by your home or a car, though it may be secured by other assets you own. This type of loan typically has a higher interest rate, a fixed term for the loan, and an adjustable rate for the credit line.
HECM reverse mortgage
A home equity conversion mortgage (HECM) is a type of government-backed reverse mortgage that allows older homeowners to borrow against their equity. This type of loan offers up-front payments, monthly payments, a line of credit, or a combination of these. It doesn't require repayment until the borrower dies, moves out of their home, or sells it.
Learn more: What is a HECM reverse mortgage, and do you qualify?
Home equity line of credit FAQs
What does HELOC stand for?
The term “HELOC” stands for home equity line of credit. It’s a type of second mortgage that allows you to access cash by tapping the equity you’ve accumulated in your house.
What is a disadvantage of a home equity line of credit?
The biggest disadvantage of a home equity line of credit (HELOC) is that most come with variable interest rates, meaning your payments can change over time. They also put your home at risk of foreclosure if you fail to make your payments.
Is it hard to get a HELOC?
The exact requirements will depend on your lender, but you’ll usually need at least 20% equity in your home, a decent credit score, a low debt-to-income ratio, and enough income to support both your HELOC payment and your existing mortgage payment.
Do you pay back a HELOC?
Yes, you pay back a HELOC, but regular payments typically don’t start for many years. In the initial draw period, you’ll usually make interest-only payments. Then, once your draw period is over and you cannot withdraw any additional money, you'll enter the repayment period, which can be as long as 20 years. At that point, you'll pay interest on your HELOC along with the principal.
What are typical terms and interest rates for a HELOC?
A typical HELOC term can last 30 years, with a 10-year draw period and a 20-year repayment period. HELOC rates depend on your term length and financial profile, but you can expect to pay around 7.50% to 10% right now.
What’s the monthly payment on a $50,000 HELOC?
That depends on what interest rate you qualify for and your HELOC’s term length. Whether the rate is adjustable or fixed will factor in too, so get quotes from several lenders. This will allow you to get the best possible deal.
Can you use a HELOC for anything?
There are no limitations on how you can use the money from your HELOC. Just remember that the interest paid on a HELOC is only tax deductible if you use the funds to buy, build, or substantially improve your home, per IRS rules.
This article was edited by Laura Grace Tarpley.
