A Home Equity Line of Credit (HELOC) is one of the most flexible ways for homeowners to tap the value they’ve built in their property. It functions like a revolving credit line secured by your home, often with a variable interest rate and a multi-year “draw” period followed by a longer repayment phase. This guide explains how a HELOC works, what affects HELOC rates, common terms and fees, how to shop and compare offers, and best practices to use a home equity line of credit responsibly.
What Is a Home Equity Line of Credit?
A home equity line of credit (HELOC) is a loan secured by your home that operates as a reusable line of credit. Instead of receiving one lump sum, you can borrow, repay, and borrow again up to your limit during the draw period. Because the HELOC is secured by real estate, rates are typically lower than unsecured credit such as personal loans or credit cards, but your home is collateral—missed payments can lead to foreclosure.
- Revolving structure: Borrow what you need, when you need it, up to a preset limit.
- Variable interest rate: Usually tied to an index (commonly the prime rate) plus a margin.
- Two phases: Draw period (often 5–10 years) and repayment period (often 10–20 years).
- Second lien: Most HELOCs are second mortgages, subordinate to your first mortgage.
HELOC vs. Home Equity Loan (HEL)
A home equity loan (sometimes called a “second mortgage”) provides a lump sum at a fixed rate and fixed payment. A HELOC offers flexibility: you can draw funds as needed and often pay interest-only during the draw period. If you prefer predictability, a home equity loan may be better. If you need ongoing access—say for multi-stage renovations—a home equity line of credit is typically preferable.
HELOC vs. Cash-Out Refinance
A cash-out refinance replaces your existing mortgage with a larger one, giving you cash at closing and one combined payment—ideally at a competitive rate. However, it resets the clock on your mortgage and may not make sense if your current first-mortgage rate is low. A HELOC leaves your first mortgage intact and adds a smaller, flexible line for just the extra funds you need.
How a HELOC Works
A home equity LOC is structured around two distinct phases:
- Draw period: Typically 5–10 years. You can borrow and repay any number of times, often with interest-only payments. Many lenders issue a card or checks to access funds.
- Repayment period: Commonly 10–20 years. The line closes to new borrowing, and the outstanding balance is amortized—principal plus interest—over the remaining term.
Some lenders offer convert-to-fixed or “lock” features, allowing you to convert part or all of your outstanding HELOC balance into a fixed-rate, fixed-payment sub-loan while keeping the remaining line open and variable. This can smooth your budget if rates are rising.
Index + Margin: The Mechanics Behind HELOC Rates
Most HELOCs use a variable rate calculated as an index plus a margin. The most common index is the U.S. prime rate. Your margin is set by the lender based on your credit profile and property characteristics. For example, if prime is 8.50% and your margin is +1.00%, your HELOC rate would be 9.50%. As the prime rate moves, your payment changes accordingly.
- Index: Often the prime rate, which moves as broader interest rates change.
- Margin: A fixed markup determined at origination based on risk factors.
- Rate adjustments: HELOC rates typically adjust monthly, but check your lender’s terms.
Variable vs. Fixed Options
A standard variable-rate HELOC rises and falls with the index. Some lenders offer fixed-rate HELOC segments (or “rate locks”) that let you convert a portion of your balance to a fixed rate for a set term—useful if you plan to carry a balance for years or expect rate volatility. These segments often have rules on minimum amounts or fees.
Rate Caps, Floors, and Minimum Payment Rules
Most HELOCs include a rate cap—a maximum interest rate allowed—and sometimes a rate floor, a minimum rate even if the index declines. During the draw period, a common minimum payment is interest-only, though some lenders require small principal payments. During repayment, the payment covers principal and interest to amortize the line before maturity. True negative amortization (paying less than the interest due) is generally not allowed in modern HELOCs.
HELOC Rates: What Drives Them
Because a HELOC is secured by your home, the rate is lower than most unsecured loans. However, the exact rate you receive depends on multiple factors:
- Credit score (FICO): Higher scores earn lower margins.
- Combined loan-to-value (CLTV): The ratio of all mortgage balances (including the HELOC) to the property’s value. Lower CLTV typically means better pricing.
- Debt-to-income ratio (DTI): Lower DTI signals stronger repayment capacity.
- Property type and occupancy: Primary residences often price better than second homes or investment properties.
- Loan size and draw: Very small lines can price worse; large, well-qualified lines may get discounts.
- Relationship pricing: Autopay from a checking account or holding deposits with the lender can reduce your margin.
- Fees and APR: A lower stated rate with higher fees may result in a similar or higher APR. Always compare the APR, not just the headline rate.
HELOC rates usually change when the prime rate moves. Prime often tracks the federal funds rate set by the Federal Reserve, though lenders can adjust prime at their discretion. As a borrower, you can’t control the economy, but you can control your margin by improving credit, lowering CLTV with a bigger equity cushion, and shopping across lenders.
Typical Terms and Common Fees
While every lender is different, many home equity lines of credit share similar structural terms:
- Draw period: 5–10 years, interest-only payments common.
- Repayment period: 10–20 years, fully amortizing.
- Line limit: Often from $10,000 up to $500,000 or more, depending on equity and underwriting.
- CLTV caps: Frequently 80%–90% for primary residences; lower for investment properties.
Expect some combination of the following fees and costs:
- Appraisal or valuation fee: To estimate your property’s value. Some lenders use automated valuation models (AVMs) for lower costs on smaller lines.
- Title search and recording: To ensure lien priority and file your deed of trust or mortgage.
- Flood certification: To confirm flood zone status.
- Annual or maintenance fee: A modest fee charged each year for keeping the line open.
- Inactivity fee or minimum draw requirement: Some HELOCs require periodic use.
- Early termination or early closure fee: If you close the line within a specified period (often 24–36 months) after opening.
- Attorney fees (in some states): State-specific closing requirements can apply.
Many banks advertise “no closing cost” HELOCs. Those costs still exist—either the bank pays them upfront with the condition that you keep the line open for a certain period, or they recoup through a slightly higher margin. If you close early, you may need to reimburse the bank.
Eligibility and Underwriting: What Lenders Look For
Because a HELOC is a secured loan, underwriting balances borrower credit with property value and lien position. Key elements include:
- Credit score: Minimums vary by lender; 700+ typically secures better pricing, while some lenders go as low as the mid-600s, possibly with tighter terms.
- Income and employment verification: W-2s, pay stubs, tax returns (for self-employed), and possibly bank statements.
- DTI ratio: Lenders often target a maximum of 43%–50%, though this varies.
- CLTV limits: The total of your first mortgage plus HELOC relative to appraised value. An example: Home value $500,000 x 85% = $425,000 maximum CLTV. If your first mortgage is $300,000, your potential HELOC limit is up to $125,000.
- Property type: Single-family, condo, and townhome are common; manufactured homes and co-ops may have stricter rules or be ineligible.
- Occupancy: Primary residences price best; second homes and investment properties may carry higher margins and lower CLTV caps.
- Insurance: Hazard insurance is required; flood insurance if in a special flood hazard area.
How HELOC Payments Are Calculated
Two distinct phases mean two different payment calculations:
During the Draw Period (Often Interest-Only)
If your HELOC is interest-only during the draw, the monthly payment is roughly:
Payment = (Outstanding balance x Current annual rate) ÷ 12
Example: If you’ve drawn $80,000 and your current rate is 9.50%, your monthly interest-only payment is approximately $80,000 x 0.095 ÷ 12 = $633.33. When you repay principal, your payment next month shrinks, and if you borrow more, it rises.