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What Is a Home Equity Line of Credit (HELOC)?

A home equity line of credit (HELOC) is a home loan that uses the equity in your home as collateral. Because it is a revolving line of credit, much like a credit card, any payments free up money for you to spend. 

HELOCs are often used for home remodeling, improvement, or additions, but they can be used for any purpose — just like a credit card. Most lenders offer a debit card or checkbook that allows access to the HELOC. Unlike a home equity loan, HELOCs don’t have set repayments. Instead, the repayment amount is usually the interest charged during that month. 

HELOCs have a draw time, which is the length of time you can borrow from the credit line. During the draw time, you can borrow and repay as frequently as you’d like and will only have to make interest payments. Once the draw period is over, you’ll need to repay principal and interest. The typical draw period is 10 years, followed by a 20-year repayment period. Alternatively, some HELOCs have a balloon payment — a required lump sum payment — at the end of the draw period.

How Much Money Can I Borrow With a HELOC?

The HELOC limit is based on the amount of equity you have in your home, your credit score, and your debts. Lenders will also look at your total loan-to-value ratio. Depending on the lender, the limit is typically 85% of the market value of your home minus any amount owed on the first mortgage. (Lenders no longer offer HELOCs of 100% of home equity following the 2008 recession.)

Only the current market value is considered when determining the amount for a HELOC — not the amount paid for the home and usually not the potential future market value of the home.

Let’s say your home’s value is $250,000. You owe $150,000 on your first mortgage. That means you have $100,000 in home equity value ($250,000 minus the mortgage balance of $150,000). You could potentially take out up to $85,000, assuming your lender allows you to borrow up to 85 percent of your equity. But pay attention to how over-leveraging affects your financial goals.

A HELOC can be used for whatever the borrower deems necessary. Say a couple uses their HELOC funds to remodel their kitchen. After paying down the balance on the HELOC for several years, the couple’s child is going off to college and they decide to pull from their HELOC to cover tuition, since they’re still inside the 10-year draw period. This time, they can choose to make interest payments only, not paying back the principal until the payment period begins.

Investors can use a HELOC to achieve financial independence because it allows them to leverage their equity to buy multiple properties. (Here’s how to use a HELOC to buy real estate.)

HELOC vs. Home Equity Loan 

HELOCs and home equity loans both use the home’s equity as collateral. However, a HELOC is a line of credit, while a home equity loan is — as the name suggests — a straight loan. The home equity loan amount is borrowed in an upfront lump sum and repaid via monthly minimum payments over a set period, but cannot be reborrowed.

Both allow you to tap into the equity in your home, but beyond that they are very different. A HELOC lets you borrow, repay, and borrow again; a home equity loan is a lump-sum loan. The interest rate charged on a HELOC is typically a variable rate, while a home equity loan comes with a fixed rate. 

Expect to pay fees for your HELOC, much like a mortgage or home equity loan. You may see application, appraisal, attorney and title search fees, in addition to other lender-specific expenses, which might include an annual membership or participation fee. There may be transaction fees that apply to each drawdown from the HELOC, too. 

HELOC Alternatives

Instead of using a HELOC, a homeowner may use a home equity loan or do a cash-out refinance, which allows you to refinance your home and take out a larger mortgage, providing you with a lump cash sum. Refinancing also allows you to take advantage of a lower interest rate. 

Another option is a second mortgage, which allows homeowners to convert the equity in their home to cash by taking out another mortgage in addition to their primary mortgage. Alternatively, homeowners can take out personal loans or use credit cards to pay for home repairs or remodelling projects. 

Pros of a HELOC

If you want to convert your home value into money for a remodeling project, there are a number of advantages to choosing a HELOC. These lines of credit are:

  • Low-cost alternatives to credit cards or personal loans
  • Flexible in terms of what the funds can be used for and with regards to repayment, making them helpful for debt consolidation
  • Revolving, meaning that the money can be reborrowed once repaid
  • Tax-deductible under certain circumstances.

Cons of a HELOC

There are some disadvantages to a HELOC, which include:

  • Putting your home at risk — unlike a credit card, your home serves as a collateral for the HELOc and can be foreclosed on if you default
  • Closing costs that must be paid at origination, such as application fees and home appraisal fees 
  • Adjustable interest rates, which can fluctuate, unlike the fixed interest rate of a home equity loan.  

Is HELOC Interest Tax Deductible?

Thanks to the Tax Cuts and Jobs Act of 2017, interest paid on a HELOC is tax deductible under certain conditions. The funds must be used for home improvements on the property being used as collateral — interest charged on funds used to pay for college tuition, for example, isn’t tax deductible. But if those funds were used to construct a garage on the home, then the interest would be tax deductible.