HELOC Questions and Answers

If you’ve built equity in your home and need access to funds, you may be considering a home equity line of credit (HELOC) as a borrowing option.

HELOCs can offer flexibility for large expenses, ongoing projects, emergency costs, and other financial needs. But like any type of credit product, they come with potential risks and important conditions.

Before applying, it’s essential to understand how they work, what they can cost, and how they differ from other forms of credit. This article walks through what to expect, qualification requirements, and key considerations to keep in mind.

What is a HELOC and how does it work?

A home equity line of credit (HELOC) is an “open-end” line of credit secured by your home. It typically allows you to borrow funds multiple times, up to your credit limit. This line of credit is secured by the available equity in your home, which is the value of your home minus the amount you owe on the mortgage.^[1]

Because HELOCs are secured by your home, they may offer lower rates than unsecured debt such as personal loans and credit cards. However, they also come with risk – if you fall behind on payments, you could lose your home.^[2]

To better understand how a HELOC works, it’s important to read more on how home equity works, how HELOCs differ from other borrowing options, and when they may be considered a suitable borrowing option.

What is home equity?

Before qualifying for a HELOC, you typically need to have sufficient equity in your home.^[3] That’s why it helps to first understand what home equity is and how it works.

Home equity represents the portion of your home that you own outright. It’s calculated by subtracting what you owe on your mortgage from your home’s current market value. You begin building equity with your down payment and continue to do so as you make mortgage payments and reduce the loan balance.^[4]

Your equity can increase when the housing market is on the rise too – but it can also decrease if the property value drops. If your local market makes a turn for the worse and the value of the property decreases, your equity decreases as well.^[4]

How does a HELOC differ from other loans?

A HELOC isn’t the only way to borrow against your home – or borrow at all. Comparing it with other options, such as home equity loans and personal loans can help you determine which suits you best.

Let’s take a look at some of the similarities and differences between HELOCs, home equity loans, and personal loans:

Source ^[5]

HELOCs and home equity loans are similar in that both are secured by your home and often require documentation of your income, debts, and assets. They also typically have longer approval timelines of between two to six weeks, including a home appraisal to confirm your property’s value. Where they differ is in how you access funds – a home equity loan is a one-time lump sum payment, while a HELOC allows you to borrow as needed up to your credit limit during a set draw period, usually around 5 to 10 years.

Personal loans work differently. They’re unsecured, so your home isn’t at risk if you can’t make repayments. They tend to have shorter terms and faster approvals (a few days), but their interest rates are typically higher.^[5]

What can a HELOC be used for?

With HELOC credit being readily accessible during the draw period, it makes it a good choice for ongoing expenses or projects.

Here are some of the reasons you may use a HELOC:^[6]

• Big home improvement projects: This line of credit can be useful for ongoing or multi-phase projects, thanks to the flexible access to funds as needed (during the draw period).
• Debt consolidation: Typically offering lower interest rates compared with other lending products, you could save money on interest over time depending on the rates and your repayment behavior. Though, home equity loans also offer low interest rates, and could be used for debt consolidation too.
• For an emergency expense: A HELOC could provide you with access to substantial funds for significant home repairs, unforeseen medical bills not covered by insurance, or emergency travel expenses.

Key terms you need to know

Understanding key terms related to HELOCs could be helpful. Becoming familiar with interest rates, the draw period, repayment period, and loan-to-value ratio may help clarify how this type of credit works and what to expect during the borrowing process.

Draw period vs repayment period

A HELOC typically consists of two distinct phases: the draw period and the repayment period.

Draw period

The draw period often lasts 5 to 10 years and is the timeframe when you can borrow funds up to your credit limit. During this time, you can make payments and access your HELOC as needed.
Some plans require a minimum draw amount each time you borrow or a minimum outstanding balance. Typically, a special check or a credit card is used to draw on your line of credit during this period.

It's important to note your full line may not be available if your home decreases in value. In the instance of your home decreasing in value, your lender may decide not to allow you to take out additional credit under your HELOC plan, which could prevent you from accessing your full line of credit.^[1]

Repayment Period

Once the draw period ends, you can no longer borrow additional funds from your HELOC and will enter the repayment period. During this phase, you must repay the full balance you owe. Your lender may set a repayment schedule – often lasting 10 to 20 years or in some cases, you may be required to pay back the full balance at once.

Monthly payments are generally higher during the repayment period because they often include both principal and interest.^{[1] [7]}

Fixed vs variable interest rates

Most HELOCs have variable interest rates, during the draw period, meaning that your monthly payments can fluctuate. These changes are typically based on fluctuations in an index, such as the U.S. prime rate. If the index increases, your rate may rise as well, potentially increasing your monthly payments, even if you haven’t borrowed more from your credit line.

Some plans may allow you to convert part or all of your outstanding balance to a fixed interest rate, which could make your payments more predictable. However, fixed rates are usually higher than variable rates.^{[1] [7]}

Who qualifies for a HELOC?

You need to have available equity in your home, meaning the amount you owe on your home must be less than its current value. Lenders often allow you to borrow up to 85% of your home’s value minus the amount you owe.

Lenders also typically consider the following criteria to qualify applicants for a HELOC:

• Credit score and history
• Employment history
• Monthly income and debts
  ^[8]

Many lenders may require the following:

• At least 15%-20% equity in your home
• A credit score of at least 620
• A good credit history
• Debt-to-income ratio below 43%
  ^[5]

What are some of the costs associated with HELOCs?

Before taking out a HELOC it’s important to read the documents carefully to see what fees your lender may charge.

Lenders may be able to charge you the following fees:

• Application fee: A fee charged when you apply for a HELOC
• Origination, appraisal, title, or closing costs: Fees incurred when you open an account
• An inactivity fee: A fee for not using your HELOC
• An annual or membership fee: A yearly fee that you hold the HELOC
• Cancellation fee: A fee may be charged if you terminate the HELOC early, usually within the first three years
• Conversion fee: A fee for converting a portion of your balance to a fixed interest rate.

Every lender varies – you should shop around to find the best rates and borrowing options for you. However, it is important to keep these feeds in mind as part of your overall cost.
^[9]

What are the pros and cons of using a HELOC?

When considering a HELOC as a borrowing option, it’s important to factor in both the potential pros and cons. Here’s a look at some key considerations:

Pros

• Lower interest rate: HELOC rates tend to be lower than those on unsecured debt, such as credit cards and personal loans.
• Flexible access to funds: Use the funds as you need them – there’s also flexibility in how you access HELOC funds with debit cards, checks, online transfers, or ATM withdrawals.
• Interest-only payments during draw period: Some HELOCs may allow you to make interest-only payments (no principal) while you’re in the draw phase (typically 5 to 10 years), keeping monthly payments lower early on.
  ^[10]

Cons

• Variable interest rates: Most HELOCs come with variable rates, meaning your interest rate and monthly payments can change over time. If rates rise, your payments may increase, but if rates fall, your payments could decrease.
• Risk to your home: Since a HELOC is secured by your home, failing to repay could result in foreclosure. This is the same for all home equity loans.
• Fees and closing costs: Depending on the lender, there may be an origination fee, closing costs, annual fees, and transaction fees that add to the overall borrowing cost.
• Risk of reduced access: Your lender may limit your credit line if your home’s value drops or if your financial situation changes. You could also wind up owing more than what your home is worth.
  ^[10]

Sources

1. Consumer Financial Protection Bureau. “What is a home equity line of credit (HELOC)?” https://www.consumerfinance.gov/ask-cfpb/what-is-a-home-equity-line-of-credit-heloc-en-107/.
2. U.S. Bank. “Home Equity Line of Credit (HELOC).” https://www.usbank.com/home-loans/home-equity/home-equity-line-of-credit.html.
3. Chase. “How Much Equity Do I Need for a HELOC?” https://www.chase.com/personal/mortgage/education/financing-a-home/heloc-eligibility.
4. Rocket Mortgage. “What Is Home Equity?” https://www.rocketmortgage.com/learn/home-equity.
5. Navy Federal Credit Union. “HELOC vs. Home Equity Loan vs. Personal Loan: What's the Difference?” https://www.navyfederal.org/makingcents/home-ownership/heloc-home-equity-loan-vs-personal-loan.html.
6. Navy Federal Credit Union. “The Best Times to Tap Home Equity.” https://www.navyfederal.org/makingcents/home-ownership/best-times-to-take-equity-out-of-your-home.html.
7. Consumer Financial Protection Bureau. “What You Should Know About Home Equity Lines of Credit.” https://files.consumerfinance.gov/f/documents/cfpb_heloc-brochure.pdf.
8. Bank of America. “What is a Home Equity Line of Credit?” https://www.bankofamerica.com/mortgage/learn/what-is-a-home-equity-line-of-credit/.
9. Consumer Financial Protection Bureau. “What fees can I be charged on a home equity line of credit?” https://www.consumerfinance.gov/ask-cfpb/what-fees-can-i-be-charged-on-a-home-equity-line-of-credit-en-1467.
10. Bankrate. “Pros and Cons of a Home Equity Line of Credit (HELOC).” https://www.bankrate.com/home-equity/pros-cons-of-home-equity-lines/.

About the author

Becca has over 10 years of experience as a content writer, working across various industries including finance, digital marketing, education, travel, and technology. Her work has been featured in publications including Forbes, Business Insider, AOL, Yahoo, GOBankingRates, and more.

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