What Is a Home Equity Line of Credit?
If you need cash as a homeowner, a HELOC is one option
A home equity line of credit—often referred to as a HELOC—is a revolving line of credit. The revolving nature of the loan means you can borrow from it, repay what you borrow, and borrow again. The amount of credit you can access is based on how much equity you have in your home.
A home equity line of credit is different from a home equity loan. Home equity loans offer lump-sum payments based on your home equity. HELOCs are lines of credit that you can pull from as needed for a set period of time.
How a HELOC Works
HELOCs work similarly to credit cards. In fact, you may actually be given a credit card or special checks to access your cash.
All HELOCs come with a draw period—or a set period in which you can pull from your credit line. During this timeframe, you’ll need to make minimum monthly payments to your lender. These payments are made in addition to your existing monthly mortgage payment (i.e., it’s a second mortgage).
Once the draw period comes to a close—and depending on how your HELOC is structured—you might continue paying back your loan over time, or in some cases, owe a lump-sum payment for the remainder of the balance.
Also similar to a credit card, the amount you borrow is flexible. While you can’t exceed the maximum amount offered by your lender, you can opt to borrow less.
HELOCs are tied directly to the value of your home. If your home value depreciates for some reason, your lender could reduce the amount of credit you’re eligible to draw from.
What Is a HELOC for?
Homeowners often use HELOCs to cover renovations or home improvements or to pay for large expenses, like tuition, medical bills, and more. Some homeowners also use HELOCs for debt consolidation—they use the HELOC to pay off other, higher-interest debts.
Because HELOCs use your home as collateral and come with higher interest rates than other options—like a cash-out refinance, for example. It’s usually not wise to use HELOCs for small or everyday expenses.
Pros and Cons of HELOCs
As with all loan options, there are advantages and disadvantages that come with HELOCs. One positive is they can offer you significant amounts of cash. That can be a huge help if you’re in a pinch or have a big expense coming up.
Another advantage is flexibility. Unlike a loan, you don’t have to take the full amount of your HELOC at once. That can be useful if you’re doing, say, a renovation, where you may not be sure ahead of time exactly how much you’ll need to borrow.
HELOCs can also come with tax benefits. If you’re intending to use the line of credit to improve your home, you can actually deduct the interest you pay from your annual income taxes.
HELOCs are also risky. They use your home as collateral, meaning failure to repay puts your property at risk. They also usually come with variable interest rates, which means your payments might be unpredictable, making it hard to budget for and stay current.
Finally, HELOCs aren’t free to take out. You’ll usually need to pay an application fee, appraisal fee, as well as various closing costs. Some HELOCs also come with annual maintenance fees and transaction fees.
Can help cover large expenses
Interest payments may be deductible
Can borrow a flexible amount
Requires a second monthly payment
Uses your home as collateral
Have unpredictable, variable interest rates
Come with various up-front costs
How to Get a HELOC
As with any home loan, you should shop around when seeking out a HELOC. The terms of rates on home equity lines of credit vary greatly by the lender, so speak with a few options before deciding who to go with.
You’ll want to look at things like:
- Terms and conditions: How long is the draw period? When does the full balance become due?
- Interest rates: Is the rate variable or fixed? If it’s variable, what’s the cap? What index is it tied to? You should also make sure you know about any introductory rates that could rise over time.
- Up-front costs: How do charges like closing costs, application fees, title searches, and other expenses compare? Are you planning on drawing enough funds to make those costs worth it?
- Long-term costs: What’s the annual percentage rate? Also, consider any annual maintenance and membership fees.
Once you choose your lender, they’ll look at your income, credit history, monthly debts, and other financial details to determine whether you qualify for a HELOC, and, if so, how much equity you can draw.
A HELOC can be a solid choice if you’re looking to fund a high-dollar purchase and want to spread its costs out over time. Still, they do come with risks, as well as many up-front expenses. Make sure you compare your options and understand the long-term costs and risks before going forward.
Consumer Financial Protection Bureau, "What you should know about home equity lines of credit," Accessed Oct. 28, 2019
IRS: "Tax reform brought significant changes to itemized deductions." Accessed Oct. 28, 2019