How Does a Home Equity Line of Credit Work?

A home equity line of credit—also known as a HELOC—can be a convenient and cost-effective personal finance tool.

There are many popular reasons for acquiring a line of credit on your home, including consolidating high-interest credit cards or car loans, and financing a home improvement. One benefit of taking out a HELOC—rather than a credit card or business line of credit—is that the interest may be tax-deductible. (Please consult a tax adviser for further information regarding the potential deductibility of interest and charges.)

For homeowners who have substantial equity in their property, a HELOC can be an affordable line of credit. Here is how it works:

Applying for a HELOC

To get a home equity line of credit, the property owner applies with a lender. The lender considers the property's market value and outstanding debts against the home, as well as the borrower's income, credit score, and other outstanding debt.

Typically, a bank may extend credit up to 80% of the home's value, minus the outstanding mortgage. For example, if a house appraises for $300,000, and the borrower has an outstanding $200,000 mortgage, a typical borrower may qualify for a $40,000 HELOC.

To access this money, the borrower is issued special checks, and/or a debit/credit card. Expect the lender to establish requirements for withdrawals, including a minimum on any sum you withdraw, an initial draw limit, and a minimum outstanding balance you must maintain.

Borrowing and paying

The borrower has a certain period of time during which they can take out the money—typically up to 5 to 25-30 years. This is the draw period. During the draw period, monthly payments must be made, though these payments are usually interest-only.

There is another established period of time to repay the balance, which includes both the principal and any interest. A HELOC is different from a home equity loan; it's a revolving line of credit, and the borrower does not have to use the entire sum available. Instead, they may borrow against it as needed—much like a credit card.

The borrower must pay off the HELOC balance by the pay-off date or in the event the property is sold. Since the lender has a lien against your home securing the credit line, defaulting on a HELOC can put the borrower at risk of home foreclosure.

Understanding your HELOC offer

HELOCs are usually variable rate, meaning they fluctuate as prime rates go up and down. When comparing different HELOC offers, it's important to ask whether the rate offered is a discounted rate or an introductory rate—meaning it's a lower rate for a fixed period of time, typically three or six months.

Like with any financial product, it's important to shop around to find the best deal. Do your research online, compare terms, and ask those in your network to recommend a reputable bank.

Ready to open a home equity line of credit? Learn More