What Is a HELOC Loan? A Complete Guide to Home Equity Lines of Credit

For homeowners looking for a source of cash to tap into, a home equity line of credit (HELOC) can be an attractive option. A HELOC grants you access to the equity you've built up in your home at lower interest rates than other forms of unsecured credit, like personal loans and credit cards. 

Whether you need to fund home renovations, consolidate debt, or pay for a major expense, a HELOC can be a useful tool. Here's what you need to know if you’re considering this popular lending option.

What is a HELOC loan?

A HELOC is a revolving credit line (meaning it can be paid back and drawn on repeatedly) backed by the equity in your home. There’s a maximum amount you can take out, but you can pay it back and draw on it multiple times without reapplying for credit.

HELOCs are used for a number of purposes, including paying off high-interest credit card debt, consolidating multiple debts, paying for home repairs or upgrades, funding large purchases, and more.

How does a HELOC loan work?

“A HELOC lets homeowners borrow against the equity they’ve built in their homes. It works like a credit card, offering a revolving line of credit during the draw period,” says Randall Yates, co-founder of VA Loan Network based in San Antonio, Texas. “Borrowers pay interest only on what they withdraw, and repayment of principal and interest begins after the draw period ends.”

The draw period (the time you can spend against your equity up to the limit) is usually about five to 10 years. You can use specialized checks or a dedicated credit card to draw money from your HELOC. Your payments during this time will be governed by the terms of your loan. It may require you to pay a certain amount of principal each month, or it may only require you to pay the monthly interest. 

When the HELOC’s draw period ends, the repayment period begins. Any remaining principal balance you’ve borrowed from the HELOC will be paid according to the lender’s schedule. This could require a balloon payment of the entire amount owed at the end of the draw period, or it could have you make scheduled payments each month until the total balance is repaid over a number of years. 

HELOC interest rates can be fixed or variable, though the latter is more common. 

What are the advantages of using a HELOC?

A HELOC is a unique variety of credit that opens up a lot of financial opportunities, as well as some risks. Here are some of the benefits and drawbacks to consider:

Pros

• Lower interest rates: Since HELOCs are secured by the equity in your home, they often carry lower interest rates than unsecured forms of debt. This makes them useful tools in paying off or consolidating high-interest debt.
• Potential to pay interest only: You may be able to pay interest only during the draw period. This allows you to make minimal payments in the beginning.
• Revolving credit: Revolving credit allows you to borrow and repay multiple times during the draw period without refiling paperwork or paying additional fees.

Cons

• Risk of losing your home: If you default on the HELOC, the lender can foreclose on your house. You won’t face this risk if you use a personal loan or credit card.
• Rates can change: Interest rates for HELOCs are usually variable. This could be a significant drawback if interest rates rise during your repayment period.
• Lenders may charge fees: To determine how much your home is worth as a basis for what you can borrow, you may have to pay for an appraisal. The lender may also charge origination and other fees.

How to qualify for a HELOC loan

For starters, you must have enough equity in your home to borrow from. Most lenders allow you to borrow no more than 80% of your home’s value, minus the balance you owe on your mortgage. As an example, let’s say your home is worth $400,000 and you owe $250,000 on your mortgage. You could borrow up to $70,000 ($400,000 value x 80% = $320,000 - $250,000 mortgage balance = $70,000). The exact amount the bank will lend you may vary based on its internal requirements and your credit. To assess the current value of your home, you’ll typically need to pay for an appraisal. 

Factors such as your credit score, credit history, debt-to-income ratio (DTI), the property type, and the bank’s internal requirements will affect how much money you can borrow. 

HELOCs vs. home equity loans

These two varieties of loans are similar in that they use your home’s equity as collateral. However, a home equity loan gives you a lump sum and requires equal payments at regular intervals, much like a mortgage. The interest rate on a home equity loan is generally fixed, and your repayment begins immediately after you take out the loan.

A HELOC, on the other hand, is a revolving credit account. You may be able to pay just interest during the draw period, but the balance continues to accrue interest during that time. Once the draw period ends, you must repay the balance according to the repayment terms of the loan.