A HELOC lets you borrow against the equity you have built in your home, then draw from that credit line as you need it

A home equity line of credit (HELOC) works like a credit card backed by your house. Your lender looks at what your home is worth, subtracts what you still owe on your mortgage, and lets you borrow up to a percentage of that difference. You do not have to take all the money at once. Instead, you get access to a credit line and draw from it when you choose, paying interest only on what you actually use.

The lender holds a second mortgage on your home as security. This means if you stop paying, the lender can foreclose — they have a legal claim on your house that comes after your primary mortgage holder. Because your home backs the loan, HELOC interest rates are usually lower than credit card rates, but the risk to you is higher.

Most HELOCs have two phases: a draw period (usually 5 to 10 years) when you can borrow and repay as often as you want, and a repayment period (usually 10 to 20 years) when you can no longer draw new money and must pay back what you borrowed.

Key Takeaways

  • You can only borrow up to a percentage of your home's equity — typically 80 to 90 percent of your home's value minus what you owe on your mortgage.
  • During the draw period, you pay interest only on the money you actually use, not on the full credit line.
  • When the draw period ends, you enter the repayment period and can no longer borrow; your monthly payment usually increases significantly.
  • Your home is collateral, so missing payments can result in foreclosure.
  • Interest rates on HELOCs are usually variable, meaning your payment can go up or down as market rates change.

How the draw period works and what you pay

During the draw period, you have a credit line — say $100,000 — that you can use whenever you need it. You might draw $20,000 one month to pay for a kitchen renovation, then draw another $15,000 six months later for a car. You only pay interest on the $20,000 and $15,000 you actually borrowed, not on the full $100,000 available.

Most lenders let you draw money by writing a check, using a debit card, or making a transfer online. Some HELOCs require a minimum draw amount — often $500 or $1,000 — each time you access the line. You can repay what you borrowed at any time without penalty, and once you repay it, that money is available to borrow again.

During the draw period, your monthly payment is usually interest-only. If you borrowed $20,000 at 7 percent interest, your payment might be around $117 per month. This is lower than a traditional loan payment because you are not paying down the principal — you are only covering the interest. Some lenders let you pay principal too if you choose, which reduces what you owe faster.

What happens when the draw period ends

When your draw period expires — say after 7 years — you enter the repayment period. You can no longer borrow new money. Instead, you must pay back everything you borrowed, usually over 10 to 20 years. Your lender will tell you the repayment schedule when you sign the HELOC agreement.

Your monthly payment jumps significantly because now you are paying both principal and interest. If you still owe $50,000 when the draw period ends and you have 15 years to repay it, your payment might jump from $300 a month to $450 or more, depending on interest rates at that time. Some borrowers are surprised by this jump and struggle to afford it.

A few HELOCs let you convert the balance to a fixed-rate loan at the end of the draw period, which locks in your interest rate and payment amount. Ask your lender whether this option is available before you sign.

Interest rates and how they change

Most HELOCs have variable interest rates, which means your rate is tied to a market index — usually the prime rate published by the Federal Reserve. When the prime rate goes up, your HELOC rate goes up. When it goes down, your rate goes down. Your lender adds a margin (usually 1 to 3 percentage points) on top of the prime rate to set your actual rate.

Because rates can change, your monthly payment can change too. If rates rise, you pay more each month. If rates fall, you pay less. Some HELOCs have a rate cap — a ceiling above which your rate cannot rise — but not all do. Read the fine print to see whether your HELOC has a cap and what it is.

A few lenders offer fixed-rate HELOCs, where your rate stays the same for the life of the loan. These are less common and usually have slightly higher rates than variable HELOCs, but your payment never changes due to market conditions.

How much you can borrow

Lenders typically let you borrow up to 80 or 90 percent of your home's equity. If your home is worth $400,000 and you owe $250,000 on your mortgage, your equity is $150,000. At 80 percent, you could borrow up to $120,000. At 90 percent, up to $135,000.

Your lender will order an appraisal to find out what your home is worth, then calculate how much you can borrow. The appraisal costs money — usually $300 to $500 — and you may have to pay it upfront or have it deducted from your credit line.

Lenders also look at your credit score, income, and debt-to-income ratio. A higher credit score and lower debt usually mean a higher credit line and a better interest rate. If your credit score is low or your debt is high, you may not be offered a HELOC at all, or you may be offered a smaller line at a higher rate.

Costs and fees to expect

Beyond interest, HELOCs come with several fees. An origination fee (usually 0 to 1 percent of the credit line) covers the lender's cost to process the loan. An appraisal fee ($300 to $500) pays for the home valuation. Some lenders charge an annual fee ($50 to $100 per year) just to keep the line open, even if you do not use it.

If you close the HELOC within a certain period — often 3 to 5 years — some lenders charge an early closure fee ($300 to $500). A few lenders charge a draw fee each time you access the line, though this is less common.

Ask the lender for a written list of all fees before you sign. Some fees are negotiable, especially if you have good credit or a large credit line.

HELOC vs. home equity loan: when to use each

A home equity loan is different from a HELOC. With a home equity loan, you borrow a lump sum upfront and repay it over a fixed period at a fixed rate. Your payment never changes. With a HELOC, you draw money as needed and usually have a variable rate that can change.

Choose a HELOC if you need money over time for multiple projects — renovations, education, or unexpected expenses — and you want to pay interest only on what you use. Choose a home equity loan if you need a specific amount upfront and you want a predictable, fixed payment.

A HELOC is riskier because your payment can rise if rates go up, and you face a payment shock when the draw period ends. A home equity loan is more predictable but less flexible — you get the money once and must repay it on a set schedule.

Frequently Asked Questions

Can I use a HELOC for anything I want?

Yes. You can use HELOC money for home renovation, debt repayment, education, a car, medical bills, or anything else. Lenders do not restrict how you spend the money. However, using a HELOC to pay off credit card debt only makes sense if you then stop using the credit cards — otherwise you end up with both debts.

What happens to my HELOC if my home value drops?

If your home loses value, your lender may reduce your credit line or freeze it entirely. During the 2008 housing crisis, many lenders froze HELOCs when home values fell, leaving borrowers unable to access money they thought they had. This is a real risk of using a HELOC.

Can I pay off my HELOC early without a penalty?

Most HELOCs have no prepayment penalty, so you can pay off the balance whenever you want. However, some lenders charge an early closure fee if you close the account within a few years. Check your agreement to see whether this applies to you.

What is the difference between a HELOC and a cash-out refinance?

A cash-out refinance replaces your entire mortgage with a new, larger one and gives you the difference in cash. A HELOC is a separate credit line on top of your mortgage. A refinance locks in a rate for 15 or 30 years; a HELOC usually has a variable rate and a draw period followed by repayment.

Do I have to use my HELOC during the draw period?

No. You can open a HELOC and never draw from it. You may pay an annual fee to keep it open, but you are not required to borrow. Some people open a HELOC as a safety net for emergencies and hope they never need it.