A home equity line of credit, known as a HELOC, gives homeowners a flexible way to borrow cash against their home equity at a relatively low cost.

However, as their name implies, HELOCs use your home as collateral. If you fail to repay your debt, the lender could foreclose.

How a HELOC Works

A home equity line of credit is a revolving line of credit that works like a credit card and is secured by your home equity. When you get a HELOC, your lender will give you a credit limit tied to the equity in your home. You can use as much or as little of your credit line as you want, at any time, and as many times as you want, usually by writing a check or using a credit card connected to the credit line.

Though there may be a fee to set up the line of credit or keep it open, you only pay interest on the amount of credit you use — not the entire available amount. If you pay off the balance, you can avoid paying interest.

Where a HELOC differs from a credit card is that HELOCs are secured loans. Your home equity is used as collateral to secure the loan. That can make HELOC interest rates much lower compared with the rates on credit cards, with the trade-off being you risk foreclosure if you fail to make payments.

What is home equity?

Home equity is the difference between what your home is worth and what you owe on it. It’s the essential factor in determining how much you can borrow with a HELOC.

It’s common for lenders to allow homeowners to borrow no more than 80% of their home equity. If your home is worth $400,000 and your mortgage balance is $250,000, then you would have $150,000 in home equity and could set up a HELOC with a maximum credit limit of $120,000, if qualified.

Variable vs. fixed rate

HELOCs usually have a variable or adjustable interest rate, which means that it can change based on market fluctuations. If the interest rate on your HELOC increases, your monthly payment will get bigger. This makes HELOCs less predictable than mortgages or home equity loans with fixed interest rates.

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How To Get a HELOC

Applying for a home equity line of credit involves many of the same steps as getting a mortgage. You’ll need to find a lender and document your finances and your property.

Once you’ve compared mortgage offers and chosen a lender, you’ll have to apply for the HELOC and provide your financial documents. Depending on the lender, you may have to speak with the lender to discuss the details of your application.

If you receive initial approval, then the lender likely will order a home appraisal to determine how much equity you have and to make sure your home is worth enough to serve as collateral for the HELOC.

If everything checks out, then you can sign all the paperwork and close on the loan. You’ll have to pay closing costs on a HELOC, which you can expect to cost between 2% and 5% of the loan amount.

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HELOC Requirements

Even if you own a home, you aren’t guaranteed to get a HELOC when you apply. You’ll need to meet basic eligibility requirements.

Sufficient equity

Most lenders have limits on how much of your home’s value you can borrow, with the limit usually around 80%. That means if your mortgage balance is more than 80% of your home’s value, then you might not be able to get a HELOC.

Good credit

As with any loan, your credit score influences your ability to qualify for a HELOC. The better your credit, the better your chances of approval. Good credit also will help you secure a lower interest rate.

If you have poor credit, then you might not be able to get a HELOC, even if you have plenty of equity in your home. If you do qualify, then your loan likely will have a higher interest rate.

Ability to repay

Every lender wants to make sure that borrowers will be able to repay their loans. When you apply, you’ll have to show your lender that you can handle the monthly payment on a HELOC. The lender may ask for things like proof of income and examples of other debts and bills, such as your mortgage payment.

Debt-to-income ratio limits

Your debt-to-income ratio is the percentage of your gross monthly income that goes toward debt payments.

For example, if your gross monthly income is $4,000 and you have $1,000 in monthly debt payments, then your DTI ratio is 25%.

Many lenders have a DTI ratio maximum. For HELOCs, the limit can range from 36% to 47%, depending on the lender.

Using the above example, a 36% DTI ratio would mean monthly debt payments of $1,440, so you could only borrow as much as would leave you with a $440 HELOC payment. A 47% DTI ratio would mean monthly debt payments of $1,880, letting you borrow enough to create a HELOC payment of up to $880.

You can use our DTI ratio calculator to estimate yours.

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How Is a HELOC Paid Out?

A HELOC is a line of credit that you can draw from on an as-needed basis. Unlike typical loans, you don’t get a lump sum of cash, though some HELOCs may require that you draw a minimum amount from the line of credit right away. Instead, you have what’s called a draw period, which is usually about 10 years, during which you can spend your HELOC funds up to the limit.

Depending on the lender, you can get money from your HELOC by visiting the bank to make a withdrawal, using a debit card, making an online transfer to your checking account, or writing a check.

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What Can You Do With a HELOC?

One of the benefits of a HELOC is that there are relatively few restrictions on how you can use the money. You do have to repay what you borrow, though, so most homeowners prefer to spend it on projects that will help them achieve their financial goals.

Some popular uses for HELOCs include:

  • Home improvement. You can use the line of credit to fund renovation projects or a remodel. It also can be a good way to pay for home improvements that increase your property’s value, such as solar panels. In some cases, this usage may let you deduct the interest on your HELOC.
  • Debt consolidation. HELOCs often have lower interest rates than other forms of credit. If you use the funds to pay off other debts, you could save money on interest and reduce the number of bills you pay each month.
  • Financial flexibility. HELOCs let you draw money when you need it. If you want flexibility with your finances, a HELOC can offer that peace of mind.
  • Large purchases. If you have a lot of equity, a HELOC can give you a significant credit limit to draw from. That can make it better than a personal loan or credit card for big-ticket items.

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How To Repay a HELOC

With a HELOC, you typically have a 10-year draw period, during which you can take out money from the line of credit as needed. During this time, you usually only make interest payments, though you can also pay down the balance.

After the draw period, the HELOC enters the repayment period, which can last as long as 20 years. During this time, you’ll make typical loan payments that cover principal and interest until you pay off the loan. That means your payments get bigger when you enter the repayment period.

Some HELOCs have a balloon payment requirement. Instead of giving you time to pay off the loan, you’re required to pay off the full balance as soon as the draw period ends.

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Pros and Cons of a HELOC

One of the primary benefits of a HELOC is that “you only pay interest on the exact amount you borrow for the exact amount of time,” says Bill Samuel, a real estate developer and broker based in Elmhurst, Illinois. If you need flexibility, HELOCs can offer that flexibility. So long as you repay the balance quickly, you won’t pay much interest for the privilege.

Pros and Cons of HELOCs

Can draw from the line of credit multiple times.May have annual maintenance fees.
Lower interest rates than unsecured loans.Long application process compared to unsecured loans.
Only pay interest on the outstanding balance.Puts your home at risk.
Variable interest rates may increase your payment.

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HELOCs vs. Home Equity Loans

HELOCs and home equity loans both let you tap into your home equity. HELOCs offer more flexibility, while home equity loans offer more predictability.

HELOCs vs. Home Equity Loans

HELOCHome Equity Loan
You can draw cash from your home equity line as needed.Lump-sum payout.
Typically has variable interest rates and payments.Typically has fixed interest rates and payments.

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HELOCs vs. Personal Loans

HELOCs are a line of credit, while personal loans are typically fixed-rate loans with initial lump-sum distributions.

HELOCs vs. Personal Loans

HELOCPersonal Loan
Your home serves as collateral, which helps lower interest rates.Unsecured, which may lead to higher interest rates.
Can draw from your home equity multiple times, as needed.Lump-sum payout.
Longer repayment period.Shorter repayment period.
Longer application process.Faster application and approval.
Lender can foreclose on your home if you default.Lender may not foreclose on your home if you default.

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HELOCs vs. Cash-Out Refinancing

Taking out a HELOC gives you an additional loan to pay on top of your primary mortgage. A cash-out refinance lets you tap the same equity by replacing your original mortgage with a larger one, leaving you with one monthly payment to manage.

Cash-out refinancing is an attractive option for those looking to borrow a large sum of money, says Michael Branson, CEO of All Reverse Mortgage in Orange, California. “However, cash-out refinances typically come with higher interest rates and closing costs compared to home equity loans or HELOCs,” he says.

HELOCs vs. Cash-Out Refinancing

HELOCCash-Out Refinance
Loan amount based on home equity.Loan amount based on home equity.
Two monthly payments: mortgage and HELOC.Only one monthly payment.
Can draw from your line of credit multiple times, as needed.Lump-sum payout.
Lower closing costs.Higher closing costs.

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Here are answers to some frequently asked questions about HELOCs and how they work.

Can you get a HELOC with bad credit?

It’s possible — but more difficult — to get a HELOC with bad credit. If you do qualify, you’ll likely face higher fees and interest rates.

Do you need an appraisal for a HELOC?

Yes, most lenders will want to conduct an appraisal of your home to ensure that it’s worth enough to serve as collateral for your HELOC.

Can I open a HELOC and not use it?

Yes, you can open a HELOC and not use it, though some lenders require a minimum draw from the line of credit when you open the account. If you don’t use the HELOC, you’ll pay no interest and only have to pay for any fees charged.

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The Bottom Line on HELOCs

Home equity lines of credit let you turn your home into a flexible source of cash. Limit your borrowing to what you can afford to repay and make sure to use your HELOC for the right reasons, and you’ll avoid many of the common pitfalls related to HELOCs.