By Joe Dyton, WCI ContributorA home equity line of credit (HELOC) is a line of credit or a second mortgage that lets you borrow money with the available equity in your home. Your available equity is how much your house is worth minus how much you owe on your mortgage. HELOCs serve as a credit line you can use toward large expenses or even consolidate high-interest-rate debt like credit cards. You can withdraw funds from your HELOC up to your pre-determined credit limit and make monthly repayments.
Since your home is put up as collateral for this revolving line of credit, you can typically get a better interest rate than you would with an unsecured loan. That also means, however, you could lose your home if you can't make the repayments.
Keep reading to learn more about how a HELOC works, the advantages and disadvantages of a HELOC, how to get one, and more.
How Does a HELOC Work?
When you have a HELOC, you borrow against the available equity in your home. The repayment plan is similar to that of a credit card—you pay toward the outstanding balance, and as you do, your available credit increases.
A HELOC isn’t an ongoing line of credit, however. There’s a certain amount of time you have to withdraw funds and make repayments. HELOCs are divided into two periods—draw and repayment. The draw period usually lasts 10 years, and during that time, you can borrow from the HELOC up to your approved limit. The second part of the HELOC is the repayment period. At this point, you can no longer withdraw funds and must repay the principal and interest until what you’ve borrowed from the credit line is paid off. You can pay toward the principal during the draw period to help keep your minimum payments down once the repayment period begins. This period typically lasts 20 years.
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How Much Does a HELOC Cost?
Like with most loans, HELOCs come with additional costs. For example, HELOC closing costs are often between 2%-5% of your total loan amount, but they may vary depending on your lender and location.
Other costs associated with this type of credit line may include annual fees ($5-$250 per year to keep your account open), transaction fees (where you’re charged each time you make a transaction through your HELOC), early termination or cancellation fees (if you pay off or close your HELOC early; it could be a flat fee or 2%-5% of your remaining balance) and inactivity fees (in the event you don’t use your HELOC for a certain amount of time).
HELOC Requirements
Lenders’ HELOC requirements may vary, but there are some common ones you’ll have to meet to get approved:
- Low debt-to-income ratio: Your monthly debt payments divided by your monthly income. What’s considered a “low” debt-to-income ratio varies by lender, but anything that’s below 40% should leave you in good shape to get approved for a HELOC.
- Low loan-to-value ratio: How much you still owe on your mortgage vs. your home’s value. Your outstanding balance shouldn’t be more than 80% of your home’s value.
- Good credit score: Again, each lender will have their own idea of what a “good” credit score is, but your approval chances increase if your credit score is at least in the high 600s—especially if you meet the previously mentioned requirements.
Where to Get a Home Equity Line of Credit
HELOCs can be obtained in many of the same financial institutions where you'd find mortgages and home equity loans. These sources include banks, credit unions, online-only lenders, and mortgage lenders.
The best option for where you should get a HELOC depends on your personal financial situation. Compare multiple lenders and see which ones offer the low interest rates and loan terms that work within your budget. Credit unions, for example, are member-owned and typically offer competitive rates and loans.
You should look at more than just rates when shopping for a HELOC, however. Review each lender’s refinancing and prepayment policies. Find out what their debt-to-income, home equity, and credit score requirements are before you apply. Be sure to ask about what fees you can expect from the lender so you can work them into your budget.
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Pros and Cons of a Home Equity Line of Credit (HELOC)
A HELOC sounds like a great deal; you get a line of credit to help you make big purchases or pay for home renovations if needed. As long as you can keep up with the monthly repayments, you should be in good shape. While a HELOC can be beneficial if used properly, it’s essential to understand both the benefits and disadvantages of having this line of credit.
Pros of a HELOC
- Lower interest rates: HELOC interest rates are usually lower than other borrowing options, like a credit card or personal loan, because your home serves as collateral.
- Flexible fund access: A HELOC allows you to take funds when you need them, compared to traditional loans that give you a lump sum of money. This is beneficial because you only pay interest on the funds you actually borrowed.
- Possible tax deduction: You can deduct HELOC interest if the funds are used for home renovations through the 2025 tax year, according to the Internal Revenue Service.
Cons of a HELOC
- Variable interest rates: HELOCs typically have lower interest rates than other loans, but they’re variable, so they could increase at any time due to market changes. If that happens, your monthly payments can go up as well.
- Your home is at risk: Your house being collateral for a HELOC helps keep your interest rate down, but it also means you could lose your home if you suddenly can't make your monthly payments.
- Potentially higher monthly payments during the repayment period: Remember, HELOCs are broken into two periods: draw and repayment. You have the option to just pay your outstanding balance during the draw period. Once the repayment period starts, you have to pay interest and your loan’s principal, which could significantly increase your monthly payment.
Is Getting a HELOC a Good Idea?
Revisiting the pros and cons of a HELOC might be the best way to determine if getting one is a good idea. If you need additional funds, a HELOC can be beneficial. You can spend the borrowed funds on almost anything, and you can spend it “as you go,” so you’re only paying interest on what you actually use rather than a lump sum. Plus, if you spend HELOC funds on home renovations or improvements, the interest could be tax-deductible.
So, getting a HELOC could be a good idea—if you know you can repay it. Remember, your home is collateral for the loan. You could lose it if you fall behind on payments. Is the risk of foreclosure worth whatever you’re borrowing the money for? If so, a HELOC could be a good idea. Otherwise, you might want to look for another alternative.
You may spend the money borrowed from a HELOC on just about anything, though financial planners often say that it's best to use a HELOC for expenses that maintain or increase your home's value. Weighing the benefits and drawbacks will help you determine if a HELOC is right for you.
Home Equity Loan vs. Home Equity Line of Credit
HELOCs and home equity loans both involve borrowing money based on your home’s equity, but that’s where the similarities end. As previously mentioned, a HELOC is a line of credit; you borrow from it as needed, as you would with a credit card.
A home equity loan, meanwhile, is a specific amount of money you borrow against your home’s equity. Once approved, you receive the money in one lump sum. Additionally, a home equity loan’s interest rates can be fixed or adjustable.
Whether a HELOC or home equity loan is the better option depends on financial need. A home equity loan might work better if you just need a one-time cash infusion. You’d repay it like you would any other loan. On the other hand, a HELOC can provide the funds you need but with a little more flexibility. You can use the money if and when you need it and only pay interest on what you used vs. what you borrowed, like you would with a home equity loan.
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Is HELOC Interest Tax-Deductible?
Interest paid on a HELOC can be tax-deductible. “Can” is the operative word because what the HELOC funds are spent on determines whether you can deduct the interest. During the tax years of 2018-2025, the interest on HELOCs used to purchase, build, or improve your home may be deductible up to certain limits, according to the IRS. If you used a HELOC to pay for things like day-to-day living expenses, college tuition, or credit card payments, the interest would not be deductible.
After 2025, however, interest paid on HELOCs may be deductible (subject to certain dollar limits), no matter why you're using the loan.
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