What Is a HELOC (Home Equity Line of Credit)?

Vault’s Viewpoint on HELOCs

• HELOCs allow you to borrow, spend and repay money using a credit line that relies on the equity you own in your home. The interest rate you pay can rise and fall.
• HELOCs feature two phases—a draw period and a repayment period. If you don’t repay your loan, you could lose your home.
• HELOC funds can be used for any reason, but the most common uses are home repair and remodeling. The Consumer Financial Protection Bureau (CFPB) discourages using HELOCs to pay off other debts or manage financial problems.

How Does a HELOC Work?

A home equity line of credit (HELOC) is a loan that relies on your home’s equity, or how much you own of your property’s value. The formula for your home equity is your home’s appraised value minus what you owe on your mortgage. You can apply for and receive a HELOC from a bank or credit union.

HELOC Limits

The amount you can borrow is based on your credit, income, how much equity you have and how much debt you have in addition to the HELOC. The limit is typically just a percentage of your equity, not the whole thing.

The lender will set a limit on the amount, but you can spend as much or as little of that amount as you choose—much like a credit card account. If you repay the borrowed amount, you can borrow it again.

The Mortgage Bankers Association’s 2023 Home Equity Lending Study indicates that the average HELOC loan balances were around $112,000 at the end of 2023. The study also noted that most people use around 34% of the HELOC funds available to them, while about 31% of people carry no balance, and 3% max out their balance.

HELOC Interest Rates

Like other types of mortgages, HELOCs have interest rates. Most HELOCs feature variable interest rates, which means rates can rise and fall, as can your payments. Your lender will inform you of a rate change on your statement before the payment is due.

The rate is variable because it’s tied to another rate that rises and falls, such as the prime rate. Then, the lender layers another percentage on top based on your creditworthiness, the credit limit or other variables up to the lender. This rate is applied to whatever amount you borrow.

If the index increases, you’ll have higher payments. For example, if the index is 3%, and the bank charges 4%, your interest rate is 7%. If the index goes up to 3.5%, your rate would increase to 7.5%. With some lenders, such as credit unions, there may be a ceiling to your percentage—for example, no more than 18%.

How Do HELOC Draw and Repayment Periods Work?

HELOCs differ from many types of loans in that they feature two different periods of borrowing and repayment. Here’s how those periods work.

The HELOC Draw Period

The draw period lasts a set amount of time, such as seven to 10 years. You’re given checks or a card to spend your credit line during your draw period. If you repay what you’ve borrowed, you can reborrow money. For this reason, a HELOC is considered a revolving account, like a credit card.

During this period, you may only be required to pay interest on what you borrow or a small of the principal (the amount you borrowed) plus interest.

Note, you could lose your home if you don’t pay your HELOC because HELOCs use your home as collateral. In this way, a HELOC is very different from a credit card. If you want to sell your home while your HELOC is active, you must repay the HELOC with the home sale proceeds.

HELOC Repayment Period

When your draw period ends, repayment is the standard next step. Repayments require payments over time that include interest and principal. However, these payments can be significant because they include principal and interest, not just interest. During this time, you can’t spend more from your HELOC.

But the following options may also be available to you:

• HELOC modification: A change to your interest rate or conversion to a fixed rate.
• HELOC renewal or Extension: A renewal or extension (including interest-only periods) of your HELOC, which will require a credit review.
• HELOC balloon payment: You pay off your HELOC balance and any interest in a lump-sum payment.
• Refinance: It may be possible to refinance your home and pay off the HELOC and your mortgage with a new loan.

How Can I Use a HELOC Loan?

Around two-thirds of borrowers use HELOC funds for home renovation and remodeling, according to the MBA’s 2023 Home Equity Lending Study. Use of HELOC funds in this way may make your interest payments tax deductible, but check with a tax professional for details.

Another quarter of borrowers use funds for debt consolidation, and another 10% of borrowers use funds for emergency cash management or other reasons. Other uses of funds could include:

• Building an accessory dwelling unit (ADU) or otherwise investing in real estate
• Paying for a child’s college tuition
• Funding or sustaining your small business instead of a business line of credit

However, the CFPB counsels against using a HELOC to manage trouble with your finances. Instead, the Bureau suggests speaking with a U.S. Department of Housing and Urban Development (HUD)-approved housing counseling agency.

Can My HELOC Be Frozen?

If home values decrease, your amount of home equity falls as well. When this happens, the bank may freeze or lower how much you can borrow. As a general rule, this can happen if your home’s value decreases so that there’s a 50% difference between the credit limit and the available equity at HELOC approval.

You can appeal this decision, but you may have to pay appraisal fees. Your appeal isn’t guaranteed to be approved.

A bank can also restrict your access to HELOC funds if it suspects you’re facing financial difficulties, such as drastic income changes or being late in HELOC payments.

How Do I Get a HELOC Loan?

You’ll need to have a source of income to qualify for a HELCO loan, but the amount of equity in your home you have is just as important, if not more so.

The more equity you have, the more you can borrow. To get a HELOC, the lender will consider the following factors.

Your Credit Score and Debts

Check your credit score and debt balances. A higher credit score will get you a better interest rate. According to the Mortgage Bankers Association report, the average FICO Score for HELOC borrowers is 769.

You’re also more likely to be approved if you don’t have much debt already—whether student loan, auto loan or other debt. To calculate your debt-to-income ratio, add up your monthly debt payments plus your potential HELOC debt. This total is then divided by your monthly gross income, which should be under 42% to 47% for HELOC approval.

Your Equity

Your equity is how much you own of your home’s total value. To find this, subtract the mortgage amount you owe from your best estimate of your home’s appraised value. You can get a ballpark appraisal figure from many home-sale sites, but remember that only a professional appraiser will decide the final value.

Your CLTV

The lender reviews your combined loan-to-value (CLTV), a ratio that compares how much the total of all mortgages would be against the value of your home.

All mortgages include your first or primary mortgage plus the potential HELOC. Every lender uses a different calculation for an acceptable CLTV. Generally, you’ll divide your mortgages by the home’s value to get a percentage. Lenders typically require a CLTV of under 85%

Comparing HELOC Options

When shopping for loans, compare interest rates and fees. However, in some cases, you’ll pay a higher interest rate across lenders—for example, if your CLTV is high or you’re borrowing for a condominium.

Federal law requires lenders to tell you the HELOC’s terms and costs, including:

• The APR, including how the variable-rate feature works or may change over time
• All fees, including application and appraisal fees, transaction fees or credit fees
• The timing and rules of your draw and repayment periods
• How your monthly payment is calculated
• Minimum advance required (the least you can take out on your HELOC)
• Any additional flood insurance or requirements you might need to meet

Lenders can charge fees while you have the HELOC, such as:

• Inactivity fees if you don’t use your HELOC
• Annual/membership fees for every year you have the HELOC
• Cancellation fees if you cancel your HELOC within the first few years of opening

Be sure to compare the total costs for the HELOCs you research, including all fees—not just the interest rate or the amount you could receive from your HELOC.