Home equity
A plain guide to the home equity line of credit (HELOC)
A HELOC lets you borrow against the value you have built up in your home, a little at a time, instead of all at once. It can be a flexible way to pay for large costs, but your home is on the line if you can't repay. Here is how it works and what to weigh first.
Key takeaways
- A HELOC is a line of credit you can draw on and repay, backed by your home.
- Lenders size the line from your home's value, what you owe, your credit, and your income.
- The payment often changes over time, because the rate is usually variable and the loan has two stages.
- Compare fees, rate caps, and terms from several lenders before you choose.
In this guide
The basicsHow lenders decide the size of your lineTwo stages, two kinds of paymentHow the rate is setFees to ask aboutHow it compares with other ways to borrow against a homeWhat can go wrongWhat to ask a lenderYour right to cancelThe basics
Equity is the share of your home you own outright: its market value minus the balance on any loan secured by it. A home equity line of credit turns part of that equity into a credit limit you can borrow against.
You don't receive the money in one go. You draw what you need, when you need it, and interest is charged only on what you have actually drawn. As you pay the balance down, that amount becomes available to borrow again, for as long as the line is open.
The home is the lender's security. That usually makes the rate lower than on a credit card or personal loan, and it also means the lender can take the home if the debt goes unpaid.
How lenders decide the size of your line
Most lenders start with your combined loan-to-value ratio: everything you would owe against the home, including the new line, as a share of what the home is worth. A common ceiling is around 80% to 85%, though each lender sets its own.
Example. A home is valued at $350,000, and $190,000 is still owed on the mortgage.
At an 80% ceiling, the most that could be borrowed against the home in total is $280,000. Subtract the $190,000 already owed, and the line could be as large as $90,000.
This is an illustration only and not an offer. The real figure depends on the appraisal, the lender's limits, your credit history, your income, and your other debts.
Two stages, two kinds of payment
A HELOC runs in two parts, and what you pay each month can look quite different in each.
When the draw stage ends, a payment that covered only interest can jump, sometimes by a lot. A few plans instead require the whole remaining balance in one payment at the end. Find out which applies to you before you sign.
How the rate is set
The rate on most HELOCs is variable. It is built from an index, often the prime rate, plus a margin the lender adds. If the index rises or falls, your rate follows.
- Starting rates. A low opening rate may last only a few months. Ask what the rate will be once it ends.
- The ceiling. The paperwork must spell out the maximum rate the line could ever be charged. Some also limit how far the rate can move at each change.
- Locking part of the balance. Some lenders let you fix the rate on a portion of what you have drawn.
Fees to ask about
Interest isn't the only cost. Before you compare lenders, ask each one for every charge in writing. Common ones include:
- An appraisal of the home.
- Application, origination, and closing costs, such as title and recording fees.
- A yearly fee for keeping the line open.
- Fees per draw, or a required minimum draw.
- A charge for closing the line within the first few years.
Where closing costs are waived, check whether you would have to repay them if you closed the line early.
How it compares with other ways to borrow against a home
A HELOC is one of three common ways to use your equity. The main differences are how the money arrives and whether your existing mortgage changes.
What can go wrong
- You could lose the home. Missing payments on a loan secured by your home can end in foreclosure.
- The payment isn't fixed. A rising rate, or the start of the repayment stage, can push it up.
- The line can be cut. If your home loses significant value, or your finances change, a lender may freeze or reduce the line.
- It comes due when you sell. The balance is normally paid off from the sale, leaving you less to take away.
What to ask a lender
- Which index is my rate tied to, what is the margin, and how often can it change?
- What is the highest the rate can ever go?
- How long do the draw and repayment stages last?
- If I pay only interest at first, what will the payment be later?
- Is there a minimum draw, a yearly fee, or a final lump-sum payment?
- What would it cost to close the line early?
- Can I fix the rate on part of the balance?
Your right to cancel
When a line of credit is secured by your main home, federal law generally lets you cancel within three business days of opening it, without penalty. The lender has to tell you about this right in writing, and if you cancel, it must refund the fees you paid to open the line.
Take your time, compare more than one offer, and only borrow what you are confident you can pay back.
About this guide. This guide explains how home equity lines of credit work in general terms. It doesn't rank or recommend any lender, and nothing in it is an offer of credit. Terms vary by lender. Read how we write our guides.