What Is a Home Equity Line of Credit (HELOC) and How Does It Work?

Most people think of their homes as assets, and they certainly can be. One way to turn your house into a cash reserve is to tap into your home equity. Home equity lines of credit (HELOCs) let you do exactly that. 

Think of a HELOC as a type of secured credit card: You get a credit limit based on your home’s value and the equity you’ve built up. You borrow funds as needed and pay them back at predetermined intervals. The caveat? Your house serves as collateral.

Read on to learn more about how HELOCs work—and whether they make sense for you.

How does a home equity line of credit work?

A HELOC lets you use your home’s equity as a revolving credit line. Unlike credit cards, HELOCs are divided into a draw period and a repayment period. The draw period can last two to 20 years, and the repayment period ranges from five to 30 years.

During your draw period, you can withdraw as much as you need up to your credit limit. If you max out your HELOC, you can pay it back and borrow again. Once you enter repayment, you can’t withdraw additional funds. You can only make payments toward your outstanding balance.

Now that you have a general idea of how HELOCs work, we can dive into the details.

What are the different types of HELOCs?

The two main types of HELOCs are:

• Interest-only HELOCs
• Fixed-rate HELOCs

Most HELOCs fall into the interest-only category because you’re not required to pay down your principal balance during the draw period. Instead, you only pay toward accrued interest.

Interest-only HELOCs are variable-rate loans, but some lenders allow you to convert a portion or all of your balance into a fixed-rate HELOC. That way, you can hedge your bets against the possibility of rising interest rates while still enjoying the potential savings of a variable rate.

The table below provides more details on each type of HELOC, as well as the differences between them:

	Interest-only HELOC	Fixed-rate HELOC
Rate type	Variable	Hybrid
Draw period payments	Interest	Principal and interest
Repayment period payments	Principal and interest	Principal and interest
When it makes sense	You need to make smaller monthly payments	You want the security of a stable interest rate
Drawbacks	You’ll pay more in interest over time	You could miss out on savings if rates decline

How much can I borrow using a home equity line of credit?

When you apply for a HELOC, lenders use your home equity and your loan-to-value ratio (LTV) to determine your credit limit.

Home equity is the difference between your home’s value and your mortgage balance. LTV is a risk assessment measure that quickly tells lenders how much you owe on your mortgage relative to what your home is worth.

Say you own a $400,000 home and owe $150,000 on your mortgage. Your home equity would be $250,000.

To calculate your LTV, we’d use these same numbers and divide your mortgage balance by your home’s value, giving us a 38% LTV.

Lower LTVs generally indicate lower debt, higher home values, or both. Many lenders won’t give you a HELOC that puts you above an 85% LTV. If you’re already near or above that threshold, what you can borrow with a HELOC may be limited.

If you’re below 85%, lenders will see how large a HELOC you can get without maxing out your equity. They’ll do this by calculating your combined loan-to-value ratio (CLTV). 

Where your regular LTV just compares your mortgage to your home’s value, CLTV weighs your HELOC, too. This formula shows how lenders use your CLTV to find out once and for all what you can borrow:

If we use the same numbers as before, the most you could borrow using a HELOC would be $190,000.

That’s a lot to cover (and a lot of math). To recap, how much you can borrow with a HELOC depends on:

1. Your home equity, which is the difference between what your home is worth and what you owe on your mortgage. Your HELOC will never be more than this amount.
2. Your LTV, which is a ratio that compares your mortgage balance to your home’s value. This gives lenders an idea of how much more debt you can take on without borrowing than your home’s value and your built-up equity.
3. Your CLTV, which ensures that your HELOC tops out at 80% to 90% of your equity. That buffer puts you (and your lender) in a less risky position should your home’s value decline before you repay your HELOC.

These are the three primary factors that determine the size of your HELOC, but your personal financial health plays a role, too.

A shaky credit history, high debt-to-income ratio, and low or irregular pay can all affect your ability to qualify for a HELOC or to qualify for a sizable HELOC limit.

How do you repay a home equity line of credit?

You will begin paying toward your HELOC every month, just like you would with a traditional loan or credit card. Your HELOC payments are based on how much you withdrew from your HELOC, your interest rate, and whether you’re in your draw or repayment period.

With most HELOCs, you only pay interest during the draw period, though you can pay more if your lender allows it. When you hit the repayment period, payments increase to include principal as well.

The only exception is if your HELOC requires you to make a balloon payment. If that’s the case, you’ll repay your entire balance when your HELOC matures at the end of your draw period. 

Through tax year 2025, the interest you pay on your HELOC can be tax-deductible if you use your HELOC for substantial home improvements. After tax year 2025, you can deduct some or all of the interest no matter how you use your HELOC.

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Tip

The tax deduction only applies to taxpayers who itemize deductions when they file their taxes, not the majority who take the standard deduction.

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In addition to your monthly payments, you’ll likely pay fees and closing costs. You might also be subject to a minimum initial draw. If your lender requires a minimum draw of $10,000, for example, your first withdrawal must be at least that much.

Some HELOC fees are assessed when you first get the line of credit, and others are recurring. Here’s a breakdown of fees you can expect and how much they might cost:

Fee	What it is	Average cost
Origination fee	Upfront fee to open the HELOC	1% – 5%
Appraisal fee	Upfront fee to determine home value	$200 – $500
Credit check	One-time fee for credit report processing	$50 – $100
Title search	Upfront fee to confirm property ownership	$75 – $200
Document preparation fee	Upfront fee to cover loan paperwork processing	$100 – $400
Maintenance fee	Annual charge for keeping the HELOC open	$25 – $75
Inactivity fee	Monthly charge for not drawing from your HELOC often enough	Up to $49
Early termination fee	One-time penalty for paying off your HELOC	$500
Conversion fee	One-time fee to convert HELOC into a fixed-rate loan	$75

Not all lenders charge the fees you see here, but some will. Be sure to ask about any added costs before you sign your loan agreement. Not all HELOC fees are avoidable, but you could save money with HELOCs with no closing costs.

It’s important to note that your home serves as collateral for the loan. This means that if you don’t make the required monthly payments, you may forfeit your homeownership. If at any point you struggle to repay your HELOC, contact your lender to explore your options.

What can a HELOC be used for?

One of our favorite aspects of HELOCs is that they’re flexible. You can use your HELOC for almost any purpose, from debt consolidation to real estate investing. Some of the most popular uses include:

• Remodeling your home
• Consolidating debts
• Purchasing a second home
• Purchasing other large investments

HELOCs can also be used to fund higher education expenses and pay back student loans.

Pros and cons of a HELOC

Pros

• Few usage restrictions

• Withdraw as much and as often as needed, up to your credit limit

• Interest may be tax-deductible

• Often have lower interest rates than other forms of financing

Cons

• Home serves as collateral

• May have to borrow more than you need if lender requires minimum initial draw

• Access to credit line is limited to your draw period

A key advantage of a HELOC is being able to borrow from and use your credit line as you see fit. Interest rates tend to be lower than you’d get with credit cards or home equity loans, and the interest you pay on your HELOC could even be tax-deductible. 

HELOCs aren’t without risk, however, including the possibility that you could lose your home if you fall behind on payments. 

You also can’t use your HELOC forever. You could extend your draw period by refinancing your HELOC, but if you’re not careful, you could get caught in a cycle of using debt to pay for debt.

How do you apply for a HELOC?

Applying for a HELOC is a multi-step process that can take two to six weeks from start to finish. Here’s how it works:

1. Check your credit. If you have credit cards, you might be able to see your credit score on your card issuer’s mobile app or website. You can also pull your full credit reports once a week for free.
2. Check your home’s value. You can look up your property on real estate listing sites such as Zillow to get an instant rough estimate, but your lender will have you complete a more thorough appraisal before you close on your HELOC.
3. Figure out how much you can borrow. Use our payment calculator to find your LTV and get an idea of your borrowing power.
4. Shop around for the best loan terms. Many of our preferred HELOC lenders let you prequalify with a soft credit check. Once you know your rates, you can compare lenders and see which one offers the best deal.
5. Gather your documents. If you haven’t done so already, pull your mortgage records, homeowners insurance statements, property tax bills, proof of income, and proof of identity. You’ll need these for the next step.
6. Fill out an application. After selecting a lender and getting your documents in order, submit an application. Unlike prequalification, this step requires a hard credit check.
7. If approved, review your loan terms. Your lender will provide documents that detail your HELOC amount, interest rate, draw and repayment timelines, and any applicable fees. Look over this information, and ask questions if anything is unclear.
8. Get an in-person appraisal. You might be approved for a HELOC, but your home still has to pass muster. Before you can close, your lender will schedule an appraisal to verify your home’s value.
9. Prepare for closing. If everything checks out during the appraisal, you can officially close on your HELOC. Depending on your lender, you may need to visit a physical branch to sign your loan documents, but some will let you do this online.

You won’t gain access to your HELOC until four days after closing. If you’re using your primary residence as collateral, the Federal Trade Commission gives you three days post-close to decide whether you want to proceed with opening your HELOC.

If you change your mind at any point and for any reason during those three days, you can cancel your HELOC with no penalty as long as you notify the lender in writing by the end of the third day. If you don’t cancel, you can start withdrawing from your HELOC as early as day four.

Read More

Can You Have a Cosigner on a HELOC? 

Is a HELOC right for me?

HELOCs are a sure choice for some borrowers, but they’re not the best option in all situations. To decide whether a HELOC is right for you, ask yourself these questions:

• Do you have good enough credit and a low enough LTV to qualify for a HELOC?
• Can your credit and LTV qualify you for a low interest rate?
• Can your budget handle fluctuating payments throughout your draw period? 
• What’s a bigger priority: access to a high credit line for several years or indefinite access to a lower credit line?
• Can you save money by refinancing debt with a HELOC?
• Are you comfortable using your home as collateral?

To answer these questions, you’ll need a solid understanding of your credit standing and your home’s value. Armed with that information, you can better decide whether a HELOC makes sense or another form of financing, such as a credit card or debt consolidation loan, is a better fit.

Tip

Legitimate lenders will not pressure you to make a time-urgent decision or present upfront fees. These could be warning signs of a scam.

Our expert’s take

Erin Kinkade

CFP®

In my experience, borrowers have applied for a HELOC to have funds on hand in case of an emergency or unforeseen major expense that exceeds their emergency fund—or if they prefer to access the HELOC in a low-interest-rate environment. But most of the common scenarios I’ve seen my clients use them for are home improvements and debt consolidation. 

What are the alternatives to HELOCs?

HELOCs are a flexible way to get cash out of your home, but there are other ways to borrow money when you need it. If you’re on the fence about getting a HELOC, consider these options:

Alternative	Best for
Home equity loan	Best for one-time, large expenses
Unsecured personal loan	Best for not requiring collateral
Cash-out refinance	Best for consistent monthly payments
Reverse mortgage	Best for no monthly payments

Home equity loans

Like HELOCs, home equity loans let you use your home equity to borrow large amounts and secure a low interest rate. Home equity loans, however, give you a lump-sum infusion of cash rather than a revolving credit line.

You can’t go back and borrow more money when you need it. That makes home equity loans ideal for large one-time expenses, such as consolidating many debts or paying for a hefty home improvement project.

Unsecured personal loan

Unsecured personal loans are smaller loans that don’t require collateral. They can be harder to qualify for than home equity loans or HELOCs, and they tend to carry higher interest rates. 

The benefit is that you don’t have to put your home at risk when you get a personal loan. Personal loans usually work best when you have to meet a short-term, small expense, like an unexpected bill.

Cash-out refinance

A cash-out refinance replaces your mortgage with a brand-new one that has a balance roughly equal to the value of your home. You pay off your current loan and pocket the difference as cash. 

One advantage of a cash-out refinance is that you wind up with one monthly payment, while home equity loans and HELOCs add a second loan on top of your mortgage. The downside is that a cash-out refinance replaces your mortgage with a new one, resetting your loan’s term. 

Reverse mortgage

A reverse mortgage is best for older homeowners who have significant equity in their homes. It lets them keep their home while turning it into a source of income that they can use during their retirement.

Typically, the lender gives the homeowner a lump sum or monthly payment. The homeowner makes no payments against the loan until they pass away, sell the home, or move. At that point, the home is sold to cover the loan’s balance.