What Is a HELOC? Home Equity Lines of Credit Explained
A home equity line of credit (HELOC) works a lot like a credit card — you can access money any time you need it, up to a certain limit. Your payments are based only on the amount you’ve used, and you can pay off the balance and reuse it for several years.
However, unlike a credit card, a HELOC is a secured loan tied to your home — so you’ll risk going through foreclosure if you can’t make your payments. Understanding how a HELOC works, and when it makes the most sense to use one, will help you decide if it’s the best option for you.
What is a HELOC loan?
A HELOC is a type of second mortgage that allows you to access cash as you need it. You’ll be able to make as many purchases as you’d like, as long as they don’t exceed your credit limit. You can get a HELOC even if you still have a first (or primary) mortgage on your house; the HELOC will simply be second in line to be repaid in the event of a foreclosure.
Because a HELOC is a line of credit, it functions differently from a “regular” installment loan like your first mortgage, a home equity loan or personal loan.
How a HELOC works
A HELOC has two different phases: a set period of time for you to use your credit line and another during which you repay the balance you owe.
Phase one: The HELOC draw period
Once you’re approved for a HELOC, the draw period starts. In this first phase (typically 10 years), you can borrow as much cash as you want each month up to your credit limit. To make withdrawals, you’ll have checks or a card you can swipe. And depending on your lender, you may have the option to make interest-only payments during this phase.
HELOC minimum withdrawal requirements and fees
The minimum payment required can change depending on how much you’ve borrowed and the current interest rate.
Phase two: The HELOC repayment period
Once the draw period ends, you can no longer borrow from the credit line and you’re required to repay your outstanding balance — both principal and interest. HELOCs can require repayment all at once or through monthly installments. A typical repayment period is 20 years.
How do I find the best HELOC rates and lenders?
Other steps you can take: Beef up your credit score and reduce the home equity amount you borrow. Both higher credit scores and lower LTV ratios are correlated with lower HELOC rates.
How much HELOC money can I get?
Your loan-to-value (LTV) ratio is a major factor for determining how much money you can access with a HELOC. An LTV is a borrowing limit your lender sets that’s based on your home’s appraised value, and it’s normally capped at 85%. For example, if your home is worth $100,000, then the combined total of your current mortgage and the new HELOC amount can’t exceed $85,000. Keep in mind that some lenders may set higher or lower LTV ratio limits.
You can use LendingTree’s HELOC calculator below to quickly estimate how much you could access with a HELOC.
Follow these steps to get an idea of how much you may qualify to borrow with a home equity line of credit:
- Estimate your home’s value. Try an online home value estimator or ask your real estate agent.
- Multiply your home’s value by 85%*. You’ll need to convert the percentage to a decimal; in this case you’ll multiply your value by 0.85.
- Subtract your mortgage balance from Step 2. The result is how much HELOC money you might be able to borrow.
*85% is the standard maximum LTV for a HELOC. However, if you know a specific lender’s maximum LTV is different, you can plug it in here to get a more accurate picture.
Let’s say your home is worth $400,000, your current loan balance is $250,000 and your lender sets their HELOC LTV limit at 85%.
| Enter your home’s value: | $400,000 |
| Multiply the value by .85: | X 0.85 $340,000 |
| Subtract your loan balance: | ($250,000) |
| Estimated HELOC money you may qualify for | = $90,000 |
HELOC pros and cons
HELOCs can be very convenient, though there are some pitfalls that can get you into trouble. Much like a credit card, an open credit line can make it easy to spend beyond your means. In addition, having the option to make low, interest-only monthly payments during the draw period can lead to a nasty shock when you eventually need to start making payments that include principal. And because a HELOC uses your home as collateral, in the worst-case scenario, the bank could foreclose on your home if you can’t repay it.
| Pros | Cons |
|---|---|
You can use the credit line as needed You'll likely pay a lower interest rate than personal loan or credit card APRs You can typically make low, interest-only payments for a set time period You may be able to write off your interest at tax time if your HELOC funds are used for home improvements You can avoid private mortgage insurance (PMI) even if you finance more than 80% of your home's value | You may have monthly maintenance and membership fees, and could be charged a prepayment penalty if you try to close out the loan early Your HELOC rate is usually variable You’ll usually have to pay closing costs ranging from 2% to 5% of the HELOC’s limit Your payments could become unaffordable once you enter the repayment period You could lose your home to foreclosure if you default on your HELOC |
HELOC requirements
To qualify for a HELOC, you’ll need to provide financial documents, like W-2s and bank statements — these allow the lender to verify your income, assets, employment and credit scores.
Expect to meet these HELOC loan requirements:
Minimum 620 credit score
You’ll need a minimum 620 score, though the most competitive rates typically go to borrowers with scores of 780 or higher. You can get your free credit score here.
Can I get a HELOC with bad credit?
Debt-to-income (DTI) ratio under 43%
This is your total debt (including your housing payments) divided by your gross monthly income. Typically, your DTI ratio shouldn’t exceed 43% for a HELOC, but some lenders may stretch the limit to 50%. Here’s how to calculate your DTI.
Loan-to-value (LTV) ratio under 85%
Your potential lender will order a home appraisal and compare your home’s value to how much you want to borrow. The LTV ratio is normally capped at 85%, according to the Federal Trade Commission (FTC).
Watch out for falling home values
Borrowers should watch out for freezes or reductions in available HELOC funds if home values drop significantly during the HELOC’s term, according to the Consumer Financial Protection Bureau (CFPB). Lenders may do ongoing home value checks and adjust how much you can borrow.
How to get a home equity line of credit
Getting a HELOC is similar to getting a mortgage or any other loan secured by your home. You’ll need to provide information about yourself (as well as any co-borrowers) and your home.
Step 1. Make sure a HELOC is the right move for you
HELOCs are best when you need large amounts of cash on an ongoing basis: for example, covering home improvement projects or paying off medical bills. If you’re unsure what option is best for you, compare different loan types, such as a cash-out refinance or home equity loan.
But whatever you choose, make sure you have a plan to repay the HELOC.
Step 2. Gather documents
You’ll need to provide lenders with documentation about your home, your finances — including your income and employment status — and any other debt you’re carrying.
Step 3. Apply to HELOC lenders
Apply with a few lenders and compare what they offer regarding rates, fees, maximum loan amounts and repayment periods. It doesn’t hurt your credit to apply with multiple HELOC lenders any more than it does to apply with just one, as long as you do the applications within a 45-day window. You could get up to five HELOC offers from lenders at once using LendingTree.
Step 4. Compare offers
Take a critical look at the offers on your plate. Consider total costs, the length of the phases and any minimums and maximums.
Step 5. Close on your HELOC
If everything looks good and it’s the right move, sign on the dotted line! Make sure you’re prepared to cover closing costs, which can range from 2% to 5% of the HELOC’s credit line amount. (However, you might be able to get a discount on these costs if you work with a lender you have an existing relationship with.)
Home equity loan vs. HELOC
A home equity loan is another second mortgage option that allows you to tap your home equity. Instead of a line of credit, though, you’ll receive an upfront lump sum and make fixed payments in equal installments for the life of the loan. Since you can usually borrow roughly the same amount of money with both loan types, deciding on a home equity loan versus HELOC may depend largely on whether you want a fixed or variable interest rate and how often you want to access funds.
Is a home equity loan better than a HELOC?
The answer to this question will depend on your needs. A home equity loan is good when you need a large sum of cash upfront and you like fixed monthly payments, while a HELOC may work better if you have ongoing expenses.
Cash-out refinance vs. HELOC
A cash-out refinance replaces your current mortgage with a larger loan, allowing you to “cash out” the difference between the two amounts. The maximum LTV ratio for most cash-out refinance programs is 80% — however, the VA cash-out refinance program is an exception, allowing military borrowers to tap up to 90% of their home’s value with a loan backed by the U.S. Department of Veterans Affairs (VA).
Is a cash-out refinance better than a HELOC?
A cash-out refinance may be better if changing the terms of your current home loan will benefit you financially. However, since interest rates are currently high, it’s unlikely that right now you’ll get a rate lower than your original mortgage’s.
A HELOC may make more sense for you if you want to leave your original mortgage untouched, but in exchange you’ll usually have to pay a higher interest rate and may also have to accept a variable rate. For a more in-depth comparison of your options for tapping your home equity, check out our article comparing cash-out refinance versus HELOC versus home equity loan.
HELOC vs. personal loan
A personal loan isn’t secured by any collateral and is available through private lenders. Personal loan repayment terms are usually shorter, though the interest rates are higher than HELOCs.
Is a HELOC a good idea?
A HELOC can be a good idea if you have ongoing expenses and a set plan to pay off the loan. It can be a great funding source for home improvement projects, debt consolidation, education expenses or medical bills.
But a HELOC isn’t a good idea if you don’t have a solid financial plan to repay it — you could lose your home.
Frequently asked questions
No. HELOC rates are typically variable, but you could convert a variable-rate HELOC into a fixed-rate loan by refinancing your principal balance. You can do that with the same lender or a new one.
It can take two to six weeks from your first application submission to when you receive your HELOC card or checks in the mail.
When you apply for almost any loan, the hard credit inquiry will cause your credit score to dip by a few points — but only temporarily. As you make payments on time and in full, your credit score will benefit. However, if you default on the loan, or if the lender forecloses on your home, your score will take a large hit.
You can cancel a HELOC for any reason within three business days after your closing (though you will have to do it in writing), and the lender must refund any fees you’ve already paid. This three-day time period includes Saturdays, but not Sundays. If you can prove that the lender didn’t provide all of the required material about the HELOC, you could get up to three years to cancel the credit line.
If neither of these solutions apply, your best bet may be to refinance your HELOC by getting another loan. Look at your contract to see if there are any penalties for early payoff. You could pay it off with your savings, another loan or even another, better HELOC.