What is a home equity line of credit, or HELOC?

A HELOC is a variable-rate home equity loan that works something like a credit card. It’s different from a home equity loan.

With a home equity loan, you get a lump sum all at once. With a HELOC, you’re given a line of credit that’s available for a set time frame, usually up to 10 years. This is called the draw period — during this time, you can withdraw money as you need it.

You can typically choose between a HELOC with an interest-only draw period and one that allows you to pay both interest and principal, helping you pay the line of credit off faster.

When the line of credit’s draw period expires, you enter the repayment period, which can last up to 20 years. You’ll pay back the outstanding balance that you borrowed, as well as any interest owed. A lender may allow you to renew the credit line.

HELOC rates are variable and are tied to a benchmark interest rate. As the prime rate moves up or down, so does your HELOC rate. Payments vary depending on the interest rate and how much money you have used. However, some lenders will allow you to convert an adjustable rate into a fixed rate.

Reasons to use a HELOC

HELOCs are often used for home improvement projects like kitchen remodels or additions. Some homeowners use a HELOC for debt consolidation, paying off high-interest credit card bills. Tapping the equity on your house to pay off debt does come with the risk of potentially losing your home, if you find yourself unable to make the payments. Homeowners use HELOCs to fund all sorts of needs. Popular ways homeowners use HELOC funds include:

• Medical expenses.
• Large purchases.
• Tuition or education costs.

What are the pros and cons of HELOCs?

HELOCs offer a combination of relatively low interest rates and a lot of flexibility.

If you need money over a staggered period — for example, at the beginning of each semester for the next four years to pay for a child’s college tuition or for a remodeling project that will take three years to finish — a line of credit is ideal. It gives you the flexibility to borrow only the amount you need, when you need it.

And if you borrow relatively small amounts and pay back the principal quickly, a line of credit can cost less than a home equity loan.

However, there are always risks when you take out a loan, especially one that is secured on your home. Here’s a table with some of the key considerations of getting a HELOC.

Pros and cons of HELOCs

Pros	Cons
Typically lower upfront costs than home equity loans Interest rates generally lower than credit cards Usually low or no closing costs Interest charged only on the amount of money you use	Lenders may require minimum drawdowns Interest rates can adjust upward or downward Lenders may charge a variety of fees, including annual fees, application fees, cancellation or early closure fees Late or missed payments can damage your credit

How to calculate home equity

To get a HELOC, you must have a substantial amount of equity in your home. Equity is the market value of your home less the amounts you owe on your mortgage or mortgages.

Lenders calculate the size of a HELOC they’ll approve based your loan-to-value ratio, along with other factors, like credit history. Use the Bankrate HELOC calculator to estimate the amount of money you might qualify to borrow.

Eligibility for a HELOC

In addition to estimating your home equity, lenders look at credit history, credit score, income and other debts. Most lenders require a total loan-to-value ratio of 85 percent or less, a credit score of 620 or higher and an adequate debt-to-income ratio to approve you for a home equity line of credit.

Alternatives to a HELOC

There are other options for using the value of your home equity besides a HELOC. These include home equity loans and cash-out refinancing. You could also turn to personal loans or decide to delay spending until you can save up the cash. Consider all options carefully before making your decision.

How to apply for a HELOC

With most HELOC lenders, you can generally get the application process started in just a few minutes on most lenders’ websites. You’ll simply enter some personal and financial information such as your name, address, salary, desired amount and estimated credit score.

During the approval process, you’ll be asked to provide supporting documentation and may need to schedule an appraisal of your home.

HELOC FAQs

What is a HELOC?

HELOC stands for home equity line of credit. It is a loan based on the equity of the borrower’s home. Similar to how a credit card works, it allows you to take out money and pay it back down at your own pace up to a certain amount during the draw period.

Where can I get a HELOC?

A variety of banks and lenders offer HELOCs. Our storefront can help you target the best opportunities and rates in your area. It’s always a good idea to shop around with a few lenders to compare rates, fees and loan terms.

Why should I take out a HELOC?

A HELOC can be a good idea for a number of reasons. Maybe you need to fund a home improvement project or finance your education. It is also flexible, especially if you don’t need all the money upfront. However, a HELOC is not a good idea when you aren’t in a position to pay it back or deal with the interest.

What is a HELOC draw period expiration?

The draw period expiration of a HELOC refers to a time when you can no longer draw any remaining loan amounts. This draw period expiration will vary based on the lender and the payment period you have signed on for. Some can last as long as 20 years. At the end of the draw period, the facility converts to a fixed repayment schedule, like a mortgage, where you make equal monthly payments.

Is the interest paid on a HELOC tax-deductible?

Interest paid on a HELOC is tax-deductible as long as it’s used to “buy, build or substantially improve the taxpayer’s home that secures the loan,” according to the IRS. Interest is capped at $750,000 on home loans (combined mortgage and HELOC or home equity loan). So if you had a $600,000 mortgage and $300,000 HELOC for home improvements on a house worth $1.2 million, you could only deduct the interest on the first $750,000 of the $900,000 you borrowed.

If you are using a HELOC for any purpose other than home improvement (such as starting a business or consolidating high-interest debt), you cannot deduct interest under the new tax law.