A HELOC is a credit line secured by your home's equity

A HELOC (home equity line of credit) is a revolving credit account that lets you borrow against the equity you have built up in your home. Unlike a home equity loan, which gives you one lump sum upfront, a HELOC works more like a credit card — you have access to a credit limit and draw from it as you need the money. The lender holds a second mortgage on your home as collateral, which is why the interest rate is typically lower than credit cards or personal loans.

The key difference from a regular loan is that you only pay interest on the money you actually borrow, not on the full credit limit. If your HELOC limit is $50,000 but you only draw $10,000, you pay interest only on that $10,000. You can repay what you borrowed and draw again, similar to how a credit card works.

Key Takeaways

  • A HELOC gives you a credit limit based on your home's equity, and you draw money as needed rather than receiving it all at once.
  • You only pay interest on the amount you borrow, not on your full credit limit, which can make it cheaper than other types of borrowing.
  • Most HELOCs have a draw period (usually 5 to 10 years) when you can borrow, followed by a repayment period when you can no longer draw but must pay back what you owe.
  • Because your home secures the debt, the lender can foreclose if you stop making payments, putting your house at risk.
  • Interest rates on HELOCs are usually variable, meaning your monthly payment can go up or down as market rates change.

How the draw period and repayment period work

A HELOC typically has two phases. During the draw period, usually lasting 5 to 10 years, you can borrow money whenever you want up to your credit limit. You make minimum payments during this time, which often cover only the interest you owe. Some lenders let you pay interest-only; others require you to pay down some principal as well.

After the draw period ends, the repayment period begins, usually lasting 10 to 20 years. At this point, you can no longer borrow new money. Instead, you must repay the full balance of what you borrowed, plus interest. Your monthly payment jumps significantly because now you are paying both principal and interest, and you have a fixed important date to pay it off.

This structure means your payment can change twice: once when the draw period ends and your payment obligation shifts, and again if your interest rate adjusts during either phase. Some people refinance or pay off their HELOC before the repayment period begins to avoid the payment shock.

Understanding variable interest rates and payment changes

Most HELOCs have variable interest rates, which means the rate moves up and down based on market conditions. Your rate is typically tied to a benchmark like the prime rate, plus a margin the lender adds. When the benchmark rises, your rate rises, and your monthly payment increases. When it falls, your payment decreases.

This is different from a fixed-rate home equity loan, where your rate and payment stay the same for the entire loan term. With a HELOC, you might pay $200 a month one year and $300 the next, depending on rate changes. Some HELOCs offer an option to lock in a fixed rate on part or all of your balance, which protects you from future increases but usually comes with a higher rate than the variable option.

Before opening a HELOC, ask your lender what the current rate is, what index it is tied to, and what the margin is. Also ask whether there is a rate cap — a maximum rate you will never pay, no matter how high rates climb. Not all HELOCs have caps, and this can matter a lot if rates rise sharply.

How to calculate your available equity and credit limit

Your HELOC credit limit is based on the equity in your home. Equity is the difference between what your home is worth and what you still owe on your mortgage. If your home is worth $300,000 and you owe $200,000 on your mortgage, you have $100,000 in equity.

Lenders typically let you borrow 80 to 90 percent of your equity, though this varies. Using the example above, if you can borrow 80 percent of your $100,000 equity, your HELOC limit would be $80,000. The lender will order a home appraisal to determine your home's current value, and they will pull your credit report to assess your creditworthiness. A higher credit score and lower debt usually means a higher credit limit and better interest rate.

Keep in mind that your available equity can change. If your home value drops, your equity shrinks, and the lender may reduce your credit limit. If you pay down your mortgage, your equity grows, and you may be able to borrow more.

What happens if you cannot make payments

Because your home secures the HELOC, missing payments puts your house at risk. If you fall behind, the lender can foreclose on your home, just as your mortgage lender can. This is a serious consequence that sets a HELOC apart from unsecured debt like credit cards or personal loans.

If you are struggling to make payments, contact your lender as soon as possible. Some lenders offer forbearance, which temporarily reduces or pauses your payments, or they may work with you to modify the terms. The earlier you reach out, the more options you may have. Waiting until you are several months behind makes it much harder to find a solution.

A missed HELOC payment also damages your credit score, making it harder and more expensive to borrow money in the future. If the lender does foreclose, you lose your home and the foreclosure stays on your credit report for seven years.

HELOC vs. home equity loan: which is right for you

A home equity loan and a HELOC both let you borrow against your home's equity, but they work differently. A home equity loan gives you a single lump sum upfront with a fixed interest rate and a set repayment schedule — you know exactly what your payment will be every month. A HELOC gives you a credit line you draw from as needed, with a variable rate and payments that can change.

Choose a home equity loan if you need a specific amount of money for a one-time expense, like a major home renovation or paying off debt, and you want predictable payments. Choose a HELOC if you need ongoing access to funds over time, like for a series of home improvements, or if you want flexibility in when and how much you borrow.

Both options carry the risk of foreclosure if you cannot pay, so only borrow what you can afford to repay. Both also require you to have significant equity in your home — typically at least 15 to 20 percent — before lenders will approve you.

Common reasons people use a HELOC

People use HELOCs for many different purposes. Home renovations are common because the work often happens in phases, and you can draw money as contractors complete each stage. Some people use a HELOC to consolidate high-interest debt like credit cards, since the HELOC rate is usually lower. Others use it as an emergency fund, keeping the credit line open but only drawing if they need it.

A HELOC can also be used to pay for education, medical expenses, or to start a business. Because the rate is lower than most other borrowing options, it can be cheaper than taking out a personal loan or running up credit card debt. However, the lower rate comes with the trade-off that your home is on the line — if you cannot repay, you risk losing it.

Before using a HELOC for any purpose, make sure you have a realistic plan to repay it. The draw period may feel like information programs because you are only paying interest, but the repayment period will come, and your payment will jump significantly. Borrowing more than you can afford to repay during the repayment phase is one of the most common mistakes HELOC borrowers make.

Frequently Asked Questions

Can I use a HELOC if I still owe money on my mortgage?

Yes. A HELOC is a second lien on your home, meaning it comes after your mortgage in priority if you default. You can have both a mortgage and a HELOC at the same time. The lender will verify that you have enough equity and income to handle both payments.

What if interest rates drop during my draw period?

If you have a variable-rate HELOC, your rate will drop along with market rates, and your monthly payment will decrease. This is one advantage of a variable rate — you benefit when rates fall. The downside is that you also pay more when rates rise. Some people lock in a fixed rate partway through the draw period if they think rates will climb.

Do I have to use my entire credit limit?

No. You only pay interest on the money you actually borrow. If your limit is $50,000 and you borrow $15,000, you pay interest only on that $15,000. You can leave the rest of the credit line unused and draw from it later if you need it.

What happens to my HELOC when the draw period ends?

You can no longer borrow new money, but you still owe whatever you borrowed during the draw period. Your payment changes from interest-only (or mostly interest) to a full amortizing payment that includes both principal and interest. This payment is usually much higher than what you paid during the draw period.

Can the lender reduce my credit limit?

Yes. If your home value drops, your credit score falls, or the economy weakens, the lender can reduce your available credit limit or freeze your account. This happened to many borrowers during the 2008 housing crisis. You cannot control all these factors, but maintaining a good credit score and making all payments on time helps protect your limit.