HELOCs explained: What is a home equity line of credit?

Key takeaways

• A HELOC lets homeowners borrow against their home equity on a revolving basis, often at lower interest rates than credit cards or personal loans, making it a flexible option for large expenses or renovations.
• HELOCs come with meaningful risks, including variable interest rates, the use of the home as collateral, reduced proceeds at sale and the potential to overborrow if spending isn’t carefully managed.
• Borrowers should understand draw and repayment periods, eligibility requirements and applicable tax rules, and set firm borrowing limits to ensure the debt remains affordable over time.

A homeowner can use a home equity line of credit, or HELOC, to borrow against the equity in their home. HELOCs can be a great way to finance expensive home repairs or purchases because they often have lower interest rates than personal loans or credit cards.

A typical HELOC allows a homeowner to borrow up to 80% or 85% of their home’s equity. Homeowners replenish the equity when they make payments. They can reborrow the amount if needed.

Many banks allow easy access to HELOCs. They provide credit cards and checks that are drawn from a HELOC. Banks can also allow homeowners to transfer funds from a HELOC to a checking or savings account.

HELOCs have draw periods that typically last between five and 15 years. Monthly payments usually apply to the interest only, and the loan balance is subject to a variable interest rate.

After the draw period, a homeowner repays the amount borrowed (principal) plus interest with fixed repayment terms. Repayment periods typically are 10 or 20 years. Some lenders require homeowners to repay the entire amount borrowed at the start of the repayment period.

Interest on a HELOC may be tax deductible if the funds are used for home improvements, buying a home or building one. The Internal Revenue Service limits deductions. A tax professional can confirm eligibility.

Your equity is the portion of your home's value that you own outright. Your down payment is often immediate equity when you buy a home. After that, your equity grows with each payment as funds are allocated toward the principal and interest.

If your property’s value increases over time, you also gain equity, but the opposite happens if your home’s value declines.

To calculate your home equity, get an estimate of your home’s value. You can use Homes.com's home valuation report as a starting point to see what your property is worth. Then, subtract your mortgage loan balance from that value.

• If you buy a home for $350,000 with a 20% down payment (covering the remaining $280,000 with a mortgage), you'll have equity of $70,000 in the house.
• If the house's market value does not change over the next two years, and $15,000 of mortgage payments are applied to the principal, you would have $85,000 in equity.
• If the home's market value increases by $150,000 over those two years, you would have $235,000 in equity.

As a general rule, a HELOC can be used to borrow up to 85% of the value of your home minus the amount you owe.
Most HELOCs have a variable interest rate, which means your payments will change from month to month. Some banks and credit unions will let you convert some (or all) of your balance from a variable rate to a fixed interest rate. Fixed rates are usually higher than variable rates, but aid in budgeting since you know how much you owe each month.

HELOC loans come with risks:

• They usually have variable interest rates. If rates rise, monthly payments will, too.
• They use a homeowner’s home as collateral. Failing to pay could put the home at risk of foreclosure.
• They reduce a homeowner’s proceeds from a sale. Any unpaid balance must be settled before closing.
• They could enable homeowners to accumulate excessive debt.

Many lenders take online applications. They require these documents:

• An official form of personal identification, such as a driver's license or passport
• Income verification in the form of pay stubs and bank statements
• Documents verifying homeownership, such as tax returns, a property tax bill or mortgage statements

Lenders check credit scores, income and the value of the property. A credit score of at least 680 is common, though some accept a score as low as 620. Lenders also look for a debt-to-income ratio of 40% or less, a stable record of income and employment and proof of home insurance.
This review stage is the underwriting period, which can take up to 30 days. Homeowners will be asked to sign an agreement and pay any closing costs.

A home equity line of credit is not to be confused with a home equity loan, which provides a one-time lump sum payment rather than a revolving credit line.

Most home equity loans have a fixed rate, which may be more appealing if interest rates rise. A lender can discuss whether a HELOC or a home equity loan is best.

Homeowners can use HELOCs for almost anything, including real estate investments or debt consolidation. A HELOC may have an annual fee, a minimum amount that can be used or the withdrawal of an initial amount when the credit line is set up.

Lenders may restrict the amount taken in a HELOC if the value of a home decreases significantly. They also can freeze the account if they believe borrowers can’t repay.

• Keep track of how much you borrow and how long it will take to repay.
• Set borrowing limits. While an equity line can help pay for value-adding improvements and renovations, it should not exceed a homeowner’s ability to repay.
• Pay on time to bolster credit scores and avoid penalties and fees for late payments.

More on this topic:

• Exclusive: Citizens Financial executive explains what borrowers are pulling cash from their homes for
• Homeowners sit on record home equity but lenders spot signs of change
• Are home improvements tax deductible?

This story was updated April 2.