HELOC loan explained: Everything you need to know

Happy father holds his young son in the air on their new backyard patio made possible by a home equity line of credit (HELOC).
September 17, 2024 | Alliant Credit Union

A lot of your net worth can get locked up in your home, and you may be wondering how you can access it. One increasingly popular option is through a home equity line of credit (HELOC). This type of revolving credit is a great way to tap into your home's value, has few restrictions on how you use the funds, and often has lower interest rates than other unsecured types of loans. Whether you need some funds for sudden home repairs, are looking to consolidate debt, or just need some extra money for a big purchase, HELOCs can be a great option. Read on to get a detailed understanding of what HELOCs are, how they work and if they are the right choice for you.

What you’ll learn

What is a HELOC?

A home equity line of credit, or HELOC, is a revolving credit line that allows you to borrow against the equity in your home. Equity is the difference between the current market value of your home and the amount you still owe on your mortgage.

Like a credit card, a HELOC gives you ongoing access to funds up to a predetermined limit, but it’s secured by your home. This collateralized nature typically results in lower interest rates compared to unsecured credit lines, making it a popular choice for financing large expenses like home renovations or education.

Unlike credit cards, HELOCs don't last forever. There are two primary time periods that define a HELOC loan cycle: a draw period and a repayment period.

  • Draw period: The draw period is when you have access to the credit line, which usually lasts between five and 10 years. During this period, you can borrow as much or as little as you need, often with the flexibility to make interest-only payments.
  • Repayment period: Following the draw period, the loan enters the repayment phase, lasting 10-20 years. In this phase, you’ll need to start paying back both the principal and interest, which could increase your monthly obligations. After the repayment period ends you can no longer borrow against the credit line.

Pros of a HELOC

Data from the Federal Reserve Bank of New York shows that total HELOC balances have increased massively over the past few years after more than a decade of decline.1 While general economic factors contribute to this trend, it also reflects an increasing awareness of the advantages of HELOCs, including:

  • Flexibility: Unlike a traditional loan which provides a large upfront lump sum, a HELOC allows you to borrow money as needed during the draw period, like a credit card. You only pay interest on the amount you actually borrow, not the entire line of credit, giving you more control and flexibility over your finances.
  • Competitive interest rates: HELOCs often offer lower interest rates compared to other forms of credit, such as credit cards or personal loans, because they are secured by your home. This can result in significant savings.
  • Potential tax benefits: The interest on your HELOC may be tax-deductible if the loan is used for qualifying home improvements, making it a potentially cost-effective way to finance renovations.
  • Potential for easier qualification: Because the loan is secured by your home, it may be easier to qualify for a HELOC even if your credit score isn’t perfect, compared to unsecured loans.

Cons of a HELOC

Despite the benefits, HELOCs aren’t always the right choice. Some potential drawbacks include:

  • Variable interest rates: Many HELOCs have variable interest rates, which means your monthly payments can increase if interest rates rise. This can make budgeting difficult and potentially increase the cost of borrowing over time.
  • Risk of foreclosure: Since your home serves as collateral for the loan, if you default on your HELOC payments, you could potentially lose your home.
  • Potential to overspend: The easy access to funds can lead to overspending. Much like with a credit card, the ability to borrow repeatedly might tempt you to take on more debt than you can afford.
  • Ongoing fees: Some HELOCs come with maintenance fees, as well as upfront costs like origination fees or various closing costs. These additional expenses can add to the total cost of your loan, making it more expensive than you originally anticipated.

It's important to note that these downsides don’t apply to all HELOCs equally. For example, some may feature a fixed interest rate for an introductory period after the opening date or zero closing costs or appraisal fees. These types of differences in terms and conditions can make a significant impact on the overall cost and risk associated with a HELOC.

How much can you borrow?

The amount you can borrow with a HELOC depends on several factors that lenders consider assessing your financial situation and the value of your home.

Lenders primarily use the loan-to-value ratio and the equity you’ve built to determine your borrowing limit. This ratio compares your home’s current market value to the amount you owe on your mortgage. Typically, lenders allow you to borrow up to 85% of your home’s appraised value, minus the outstanding balance on your mortgage. For instance, if your home is valued at $400,000 and you owe $200,000, you might be able to borrow up to $140,000 through a HELOC.

Your credit score also plays a crucial role in determining how much you can borrow and at what interest rate. A higher credit score often results in a higher borrowing limit and a lower interest rate, as it reflects your ability to manage debt responsibly.

Lenders will also evaluate your debt-to-income ratio (DTI), which is the percentage of your monthly income that goes toward paying debts. A lower DTI indicates you have more disposable income to handle additional debt, which may increase your borrowing capacity.

How to qualify for a HELOC

When applying for a HELOC, lenders use a few key factors to assess your eligibility and determine the terms of your loan. First, you’ll need to have sufficient equity in your home — typically at least 15% to 20% — which means the combined loan-to-value ratio should be 85% to 80% or less. This calculation compares your mortgage balance and the HELOC amount to your home’s current market value.

Your credit score is another crucial factor. Most lenders prefer a score of 620 or higher, though scores above 700 often lead to better interest rates and terms. Additionally, your DTI ratio should ideally be under 43%, indicating that your monthly debts are manageable in relation to your income.

Lenders will also ask for proof of income, such as pay stubs or tax returns, and you will likely need to undergo a home appraisal to confirm your property’s value. Some lenders, such as Alliant, allow you to pre-qualify before submitting your application. This can give you an idea of how much you may be able to borrow and at what interest rate, without affecting your credit score.

Is a HELOC right for you?

A HELOC can be an excellent option for financing ongoing expenses, such as home renovations, that require flexible access to funds. It’s also a good choice for consolidating high-interest debt since HELOCs often have lower interest rates than credit cards.

As with any loan, you should carefully consider whether you can comfortably make any potential monthly payments and whether you’re comfortable using your home as collateral. Alternatives like personal loans might be better if you prefer fixed rates or if you’re uncomfortable with the risks associated with a HELOC.

If you do decide to pursue a HELOC, take the time to go through each lender’s terms and conditions, paying attention to interest rates, repayment periods, and any potential fees. Not all HELOCs are created equal, and some may be much better suited to your needs than others.


1 Household Debt and Credit Report - FEDERAL RESERVE BANK of NEW YORK (newyorkfed.org)

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