What Is A Home Equity Line Of Credit, Or HELOC?

A home equity line of credit (HELOC) is a variable-rate second mortgage that utilizes a portion of your home’s value through a revolving line of credit. You can use, pay down and reuse the credit line during a set time period as needed.

The amount you can borrow with a HELOC depends on your home’s value and your equity—which is your home’s value minus the amount you owe on your first mortgage. Because your house serves as collateral to secure the loan, your lender can foreclose if you fail to repay.

FEATURED PARTNER OFFER

Advertisement

New American Funding

Minimum credit score

580+

620 with a 65% LTV

HELOC Loan Rates

Lower than the national average

Days to close

Approval may be granted in five minutes but is ultimately subject to verification of income and employment, as well as verification that your property is in at least average condition with a property condition report. Five business day funding timeline assumes closing the loan with our remote online notary. Funding timelines may be longer for loans secured by properties located in counties that do not permit recording of e-signatures or that otherwise require an in-person closing.

5 days

Learn More

On New American Funding's Website

580+

620 with a 65% LTV

Lower than the national average

Approval may be granted in five minutes but is ultimately subject to verification of income and employment, as well as verification that your property is in at least average condition with a property condition report. Five business day funding timeline assumes closing the loan with our remote online notary. Funding timelines may be longer for loans secured by properties located in counties that do not permit recording of e-signatures or that otherwise require an in-person closing.

5 days

How Does a HELOC Work?

A HELOC lets you access a portion of your home’s value through a line of credit. Much like a credit card, you draw on the credit line, pay it off and reuse it during a set timeframe called the draw period. This period lasts up to 10 years, and you pay interest only on the amount you withdraw.

After the draw period, the repayment period—which typically lasts 20 years—begins and you must pay off the outstanding principal and interest. If you sell your home before the loan term is up, you’ll need to pay off the HELOC in full.

What Can You Use a HELOC For?

You can use a HELOC to pay for just about any legal expense, such as home improvements, high-interest credit card debt, medical expenses, education costs or other large expenses spread out over time. However, it’s worth noting that you won’t be eligible to deduct the interest paid on the loan unless you use the proceeds to buy, build or substantially improve your home.

HELOC Requirements

HELOC qualifications vary by lender, but standard requirements include:

• Debt-to-income (DTI) ratio of 40% or less.
• Credit score of at least 620.
• History of on-time payments.
• Demonstrated ability to pay off a line of credit.
• At least 15% equity in your home as determined by an appraisal.

While 620 is often the minimum credit score required to qualify for a HELOC—assuming you meet equity and income requirements—some lenders may have higher minimums. Keep in mind that the higher your credit score, the more competitive rates you’ll receive.

How Much Financing Can I Get Through a HELOC?

Most lenders allow you to access up to 85% of your home’s value with a HELOC. Home equity is one of the primary factors a lender evaluates when reviewing a HELOC application. To calculate your equity, find a quick estimate of your home’s value. Search your home address on real estate websites like Zillow.com or Realtor.com. These websites offer only rough estimates and your lender will likely require a formal appraisal when you apply for a HELOC.

Once you determine the market value of your home, add up the loan balance on your primary mortgage—and any other second mortgages—to find out how much you owe. Then, subtract the total mortgage balance from the home’s market value to get your equity amount.

Home’s Market Value – Total Mortgages = Amount of Equity in Home

Finally, divide your equity by the home’s appraised value to obtain your equity percentage. HELOC lenders typically look for equity between 15% and 20% of the home’s value before approval.

Equity in Home / Home’s Market Value = Equity Percentage in Home

For example, consider a home with a market value of $350,000 and $200,000 in outstanding mortgage balances. In this case, the homeowner has $150,000—or almost 43%—equity in the home and is likely to be approved for a HELOC. But if the same homeowner had $315,000 in outstanding mortgages on the same house, they would only have 10% equity in the home—less than many lenders require for a HELOC.

Current HELOC Rates

Before applying for a HELOC, shop around to compare HELOC rates and borrowing costs with multiple lenders to ensure you get the best deal for your needs. The current average interest rate for a HELOC is around 8%, according to Bankrate.

Getting the Best HELOC Rates

To get the best HELOC rates and terms, you’ll need a strong credit history and credit score, and at least 15% equity in your home. Shop around with several HELOC lenders to find the most favorable terms.

Repaying Your HELOC

Because a HELOC is a line of credit and not a traditional loan, you can draw against it as needed rather than receiving the funds as a lump sum. During the draw period, which typically lasts up to 10 years, borrowers must still make monthly interest payments on the amount they borrow. They also have the option of paying down the principal during the draw period.

After the draw period, the repayment period begins and you won’t be able to draw on the credit line any longer. During this time, usually up to 20 years, borrowers are responsible for paying the principal and remaining interest in monthly installments.

You must pay a HELOC off if the home sells before the end of the loan term, and the lender may impose a cancellation fee. As such, a HELOC may not be the best option if you aren’t planning to stay in your home long-term.

Pros and Cons of a HELOC

Pros

• Lower interest rates than credit cards and personal loans
• Flexibility to use equity from a HELOC however you want
• Interest is charged only on the amount you draw from the line of credit—not on a lump sum
• HELOC interest may be tax deductible if you use the money to buy, build or substantially improve your home

Cons

• Variable interest rates that could increase over time
• Upfront closing costs and third-party fees during the application process
• Uses your home as collateral, running the risk of foreclosure if you default
• Missing payments or failing to make them on time can damage your credit
• Some lenders require initial minimum drawdowns as a percentage of the total credit line

How To Get a HELOC

The complete HELOC application process varies by lender and can take anywhere from a few hours to weeks. When applying for a HELOC, expect to follow these general steps:

1. Check your credit. Lenders will examine your credit to determine whether you qualify for a HELOC. Request a free credit report and check your credit scores to get an initial idea of your creditworthiness.
2. Calculate your home equity. Get an estimate of your home’s value online. Then, add up all existing mortgage balances and subtract the total from your home’s value. Divide the result by the home’s value to get your home equity percentage.
3. Gather necessary documentation. When evaluating your HELOC application, lenders also require documentation of your assets, income, employment, debts and other factors that influence your ability to manage the additional debt. Compile these materials before you apply to help streamline the process.
4. Shop for the best lender. To choose the best lender for a HELOC, start with your current bank or mortgage lender. Research other lenders in your area or online to compare rates and other terms to narrow down your choices. It may be helpful to complete each lender’s prequalification process, which won’t impact your credit, to compare rates and terms.
5. Submit an application. Many lenders let borrowers apply for a HELOC online, by phone or in person. Choose the method that best suits you and submit the information and materials requested in the application.
6. Complete the underwriting process. Some lenders respond to HELOC applications in as little as a few hours while others take days or weeks. Once a lender reviews your application, someone will contact you to verify your employment and financial details and, if necessary, schedule an appraisal.
7. Close on the line of credit and receive access to funds. Following the underwriting process, a loan officer will send the final terms of the HELOC and schedule the closing. After carefully reviewing the terms, sign the paperwork to gain access to your new line of credit.

How To Increase Your HELOC Limit

The process for increasing the limit of a HELOC varies by lender. However, most lending institutions let borrowers request a line increase via phone or email. After the lender approves the increase, the outstanding HELOC balance is refinanced into a larger HELOC with revised terms and conditions, a new interest rate and updated draw and repayment periods.

Related: Best HELOC Lenders

Alternatives to a HELOC

Depending on your needs, a HELOC may not be the best fit for you. Consider these alternatives before signing on the dotted line:

Home Equity Loan

A home equity loan is a second mortgage that allows you to borrow against your home’s value, meaning your home serves as collateral, by receiving a lump-sum payment. Most home equity loans come with a fixed interest rate, and you’ll typically pay the loan back in monthly installments over five to 30 years. Because of these differences, a home equity loan may be the best choice if you qualify for a low, fixed interest rate.

Cash-Out Refinance

Cash-out refinancing involves getting a new, larger home loan that replaces your current mortgage. The loan rolls into your new mortgage, and you’ll receive the difference between your outstanding mortgage balance and the new loan amount as a lump sum.

Cash-out refinancing generally comes with lower interest rates and higher closing costs due to the larger loan amount. Choose a cash-out refinance if you want to borrow a large sum of money and can take advantage of lower interest rates.

Personal Loan

Personal loans can help homeowners borrow money without pledging their homes as collateral. Interest rates are usually higher than for HELOCs, but borrowers can get a more competitive rate by securing a personal loan with assets like a car, real estate or stocks and bonds. Keep in mind, however, that interest on a personal loan is not tax deductible.

Personal loans may not be the best option if you have substantial equity in your home and can take advantage of a HELOC or home equity loan.

Cash-Out Refinance vs. HELOC

When you have a substantial amount of equity in your home that you want to use for significant expenses, you may be eligible for a cash-out refinance or a HELOC. The main difference between these two types of loans is that with a cash-out refinance, you replace your current loan with a new loan that features a larger balance. A HELOC, however, involves taking out an additional loan while retaining your existing mortgage.

Deciding between a cash-out refinance versus a HELOC comes down to your finances, current interest rates, how much equity you have and what your cash needs are.

When To Use a HELOC

• The interest rate you have on your mortgage is already low
• You need a regular flow of cash to pay for various expenses over time
• You want a flexible financing option

When To Use a Cash-out Refinance

• The interest rate is lower than your current mortgage rate
• You need a large amount of cash sooner rather than later
• You want to lower your monthly payment by extending your term

Forbes Advisor Mortgages and Loans Writer Robin Rothstein contributed to this article.

Frequently Asked Questions (FAQs)