Some advertisements and offers on this page are from advertisers who pay us. That may influence which products we write about, but it does not affect what we write about them. Here's an explanation of how we make money and our Advertiser Disclosure.
Thanks to elevated home prices, many homeowners have found themselves with an unexpected boost in their home equity. That creates an opportunity to borrow with a home equity loan or home equity line of credit (HELOC). Whether you'll be approved for a HELOC will depend on your income, debt-to-income ratio, employment record, and credit history, as well as how much equity you have in your home.
A second mortgage 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. When you do borrow, you'll have a lot of options for how to use and repay those funds.
Dig deeper: How to determine your home value
In this article:
What is a HELOC?
A HELOC is a type of second mortgage that is a revolving credit line secured by your home equity. Your home equity is the portion of your home's value that exceeds the combined balances for your original mortgage and any home equity loan or HELOC that you have.
Unlike a home equity loan, a HELOC doesn't give you an up-front lump sum of cash. Instead, you can borrow as much or as little as you want, up to your credit limit, and then repay — and re-borrow — those amounts when you choose. A HELOC works more like a credit card than a traditional loan.
Learn more: 7 ways to build equity in your home
How does a HELOC work?
Most HELOCs have a variable interest rate, which can go up or down depending on various economic factors.
One advantage of a HELOC compared with a home equity loan is that with a HELOC, you'll only be charged interest on the amounts you borrow. That doesn't necessarily mean a HELOC that you open but never use will be free of charges. You might have to pay closing costs, various other fees, and interest.
Tip: Although HELOCS typically have adjustable rates, some HELOCs allow you to lock in a fixed interest 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. But more on that a little later.
How to get a HELOC
To be eligible for a home equity line of credit, you'll need 15% to 20% equity in your home, depending on the lender. 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 lender and prepare the necessary documentation, such as a recent mortgage statement and a government-issued ID. You'll fill out the lender's application and go through the underwriting process before closing on your second mortgage. Then, the company will instruct you on how and when you can access your money.
Read more: How to get a HELOC in 6 simple steps
How to repay your HELOC
A home equity line of credit has two distinct phases: the draw period and the repayment period.
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 the same funds repeatedly. Borrowing may be as easy as writing a check or swiping a credit card linked to your HELOC. You might also be able to request a cash advance or transfer funds from your HELOC to a checking or savings account.
The draw period is typically 10 years. At the end of your draw period, you may be able to renew your HELOC with a new draw period or by refinancing your HELOC into 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 renew or refinance, you'll have to pay off your remaining balance, including principal and interest charges, during the “repayment” period. Repayment may be due immediately as a balloon payment or over a fixed repayment term with monthly payments, depending on the terms of your HELOC agreement.
If you sell your home during either your draw or repayment period, you'll probably have to pay off your HELOC with the home sale proceeds.
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 your 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.
Learn more: Interest-only HELOC — How payments are calculated
Fixed-rate HELOCs
As previously mentioned, HELOCs typically come with variable interest rates, meaning your rate and payment can change over time. However, some mortgage lenders offer the option to transfer some or all of your HELOC balance to a fixed-rate loan.
Here are the basics on how a fixed-rate HELOC works: 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. There are several factors to consider before taking this step.
Pros
-
Tap into your home equity without affecting your original mortgage term or rate
-
Use the money however you see fit, from home improvements to paying off student loans or credit card debt
-
A line of credit gives you the option not to borrow the full amount you're approved for (and you don't pay interest on the money you don't borrow)
-
A variable interest rate means your rate could fall if market rates decrease
-
You'll usually only make interest-only payments during the draw period
-
Interest payments may be tax-deductible
Cons
-
You'll have two monthly home loan payments, not just one
-
A variable interest rate means your rate could rise if market rates increase
-
Your home is collateral for paying off your HELOC, which means there is a risk of foreclosure if you don't make payments
-
Monthly payments will increase during the repayment period, when you switch from interest-only payments to also paying off the principal
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 ongoing higher monthly payments that come with the repayment period. Here are your options for refinancing a line of credit:
-
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.
-
Cash-out refinance: This is a good choice if you're already wanting 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 balance.
-
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.
-
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
Is HELOC interest tax deductible?
Yes, you can deduct interest paid on your HELOC if you itemize your deductions when you file taxes. HELOC interest is not tax deductible if you take the standard deduction. The IRS also states that you can only deduct HELOC interest if you use the money to "buy, build, or substantially improve” your house.
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 combined.
Learn more: How to deduct interest paid on a HELOC
HELOC alternatives
If you're curious about alternatives to a HELOC, you may want a cash-out refinance, home equity loan, personal loan or personal line of credit, or home equity conversion 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 a second mortgage with a fixed loan amount and repayment term. 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 a loan that's not secured by your home or a car, though it may be secured by other assets that you own. This type of loan typically has a higher interest rate, a fixed term for the loan, and an adjustable rate for the line.
HECM
A home equity conversion mortgage (HECM), also called a "reverse mortgage," allows older homeowners to borrow against their equity. This type of loan generally doesn't require repayment until the borrower dies, moves out of their home, or sells their home.
If a HELOC sounds like a good choice for your needs, you may be ready to talk with a mortgage lender about applying for this type of credit line.
Home equity line of credit FAQs
Is a home equity line of credit the same as a HELOC?
Yes, HELOC stands for home equity line of credit.
What is a disadvantage of a home equity line of credit?
The biggest disadvantage of a home equity line of credit (HELOC) is probably that many lenders only offer HELOCs with adjustable rates, not fixed rates. This means your rate could increase later if market rates are trending upward overall.
Is it hard to get a HELOC?
It's relatively easy to get a HELOC, as long as you have enough equity in your home to qualify.
Do you pay back a HELOC?
Yes, you pay back a HELOC, since it is a type of second mortgage. Once your draw period is over and you cannot borrow money anymore, you'll enter the repayment period, which can be as long as 20 years. You'll pay interest on your HELOC along with the principal.
What are typical terms and interest rates for a HELOC?
A HELOC term can last between five and 30 years. HELOC rates depend on your term length and financial profile, but you can expect to pay around 8.50% to 9.50% right now.
Can you use a HELOC for anything?
Yes, there is no limitation on how you can use the money from your HELOC. Just remember that the interest paid on a HELOC is only tax-deductible if it's used for specific expenses like home improvements.
