Discover what a HELOC is, how it works, and its potential benefits for accessing home equity. Learn how it differs from other home financing options.
Many Americans consider their home to be their single greatest source of wealth — and a home equity line of credit (HELOC) is just one of the ways homeowners can tap into this wealth. Functioning much like a credit card and allowing homeowners to gradually withdraw cash, this financial tool allows homeowners to tap into the value of their homes to finance things like home improvement projects, investment opportunities, and debt-consolidation strategies.
What’s more: HELOCs often bring with them better interest rates than a credit card or personal loan. Simply put, a home equity line of credit is a secured line of credit that uses your home’s equity (the value of your home minus what you currently owe) as collateral.
But while a HELOC can be a great financial resource, you should first understand its many benefits, risks, and how exactly it works before deciding if it’s right for you.
Our team breaks down everything you need to know about HELOCs — how they work, how they can help (and hurt), and how to use them wisely to protect your financial well-being.
Unlike a traditional loan, where you might receive a full disbursement up front, a HELOC works like a revolving line of credit: you can borrow money, pay it back, and borrow again up to your credit limit during what’s known as the draw period. When this draw period ends, you begin paying back the money you borrowed with interest.
A HELOC allows you to borrow against your home equity, but most lenders won’t let you borrow your full equity amount. Typically, lenders will cap the amount you can borrow at 85 percent — meaning if you owe $250,000 on a $400,000 home, your HELOC will likely be limited to $127,500.
Keep in mind, however, that simply because you can borrow this six-figure sum doesn’t mean you should, as over-borrowing is one of the biggest risks homeowners face when using a HELOC.
You should also note that simply having equity doesn’t mean you’ll be able to borrow through a HELOC. Before you can borrow, lenders will assess:
In general, lenders will want you to have a credit score of 620 or higher, in addition to a debt-to-income ratio of 40 percent or below.1
HELOCs are popular alternatives to personal loans or credit cards due to their relatively low interest rates. But considering that many lenders offer HELOCs with variable interest rates, homeowners shouldn’t assume that this is automatically the safer option.
One of the best ways to protect yourself as a borrower considering a home equity line of credit is to understand how the draw period and repayment period work. The draw period begins when your loan is approved and you can begin withdrawing funds up to your credit limit. This period typically lasts for five to 10 years, during which time you’re typically only required to pay interest on what you borrow.2
After the draw period concludes, the repayment period begins and lasts up to 20 years. This is where you’ll repay the principal plus variable interest in potentially sizable monthly payments, earning the common name of “second mortgage.”
Learn more about how HELOCs compound interest.
One of the biggest reasons homeowners opt for HELOCs is their versatility. Within the confines of your credit limit, there are no parameters for what you can and can’t do with a HELOC. There are, however, ways to use a home equity line of credit to better position yourself financially, like renovating or repairing your home, thus using your home equity to improve your home equity.
You can also use a HELOC to help consolidate hefty, high-interest debt into a single loan that costs you less in interest and is easier to keep track of, so long as you can commit to avoiding high-interest debt in the future.
Education costs, emergency funds, and investment seed money all represent fairly common uses for HELOC funds. But as you ponder the potential uses for your home equity, think strategically. Is what you’re hoping to fund worth borrowing from your home? This question alone should help you determine if your equity is being put to good use.
There are myriad advantages to a HELOC, especially when compared to high-interest alternatives like personal loans and credit cards. These are just a few of the common reasons why homeowners choose HELOCs.
A HELOC isn’t the only way to leverage your home equity to accomplish your goals. Home equity loans, for example, also allow you to borrow against your home equity. But instead of borrowing cash as needed, you receive your funds in a single lump sum, potentially saddling you with a larger loan than you need and more debt than you want.
HELOCs have the upper hand when it comes to flexibility, making them the better choice in certain cases: like tackling multi-phase home improvement projects with loosely defined budgets. During the draw period, you can access funds as needed, pay your balance down, and borrow again to complete your next project.
Home equity lines of credit allow homeowners to gradually draw funds, much like a credit card. Unlike credit cards, HELOCs are secured by your property and therefore carry far lower interest rates.
As of December 2024, the average APR for a credit card sits at 24 percent.3 HELOCs, on the other hand, tend to hover between six and 10 percent. On five-figure sums required to tackle home improvement projects or consolidate several sources of debt into a single payment, this double-digit difference can equate to thousands saved in interest by opting for a HELOC over a credit card.
In addition to saving you thousands on interest and creating added financial flexibility, using a HELOC can be a benefit come tax season. If the funds from a home equity line of credit are used to renovate your home, the interest you pay (on up to a $750,000 loan) may be considered tax-deductible.4
Before basing your decision on this benefit, you’ll want to consult with a tax professional to ensure your specific situation qualifies.
For all the benefits of a HELOC, there are also significant risks worth noting. Before you use a home equity line of credit to tap into your home equity, consider the following:
While HELOCs carry lower interest rates than credit cards, these rates are typically variable, meaning they can fluctuate as frequently as every month during the life of the loan. This can make it increasingly difficult to work monthly payments into your budget, with the added uncertainty potentially bringing about more financial stress than you had to begin with.
Some lenders do offer fixed-rate HELOCs so do your research and shop around to find the loan that’s best for you.
If a home equity loan is like a bucket, filled to the brim, a home equity line of credit is like a faucet: slow, steady, but ready to disperse more funds at a moment’s notice. So, while the flexibility of a HELOC can be a blessing, it can also be a curse, with easy access to funds leading to some homeowners borrowing more than they need.
Separate borrowing and repayment periods can make overborrowing especially risky. Believing they can manage the monthly, interest-only payments, homeowners may feel comfortable borrowing more, only to be caught by surprise when the repayment period begins, and they’re confronted by their full debt obligation.
The biggest risk of using a HELOC is the impact it can have on your home equity, your wealth, and your financial future. While a home equity line of credit doesn’t allow you to draw equity directly from your home, this strategy can set you back financially. It has the potential to double your monthly mortgage payments, taking away from money that could be spent accruing more home equity.
Additionally, a HELOC must be repaid in full when you decide to sell your home. If you still owe on your HELOC, this repayment can directly eat into your sale proceeds and leave you with less home equity than you anticipated.
With all of this in mind, is a HELOC a good idea? A home equity line of credit can be a great way to leverage your home equity to accomplish a range of financial goals, from debt consolidation to ambitious (and expensive) value-adding home improvement projects. However, once factoring in the risks of a HELOC, many homeowners may decide that this approach simply isn’t worth it.
If you’re looking to access your home equity without taking on debt, Truehold’s sell and stay transaction may be a safer option. By selling your home and renting it back, you can:
Truehold supports homeowners by helping them access the wealth they’ve built in their homes. To learn more about how Truehold can aid you in achieving your financial goals as a safer alternative to a HELOC, connect with one of our representatives today.
Disclaimer*: After the home sale, you must comply with the terms of your lease to continue living in the home. This includes making timely payments on your rent for your minimum lease term (which ranges from 6 – 24 months).
Sources:
1. NerdWallet. What Is a Home Equity Line of Credit, or HELOC? https://www.nerdwallet.com/article/mortgages/heloc-home-equity-line-of-credit
2. Bankrate. What is the draw period on a HELOC and how does it work? https://www.bankrate.com/home-equity/heloc-refinance-draw-period-ends/
3. LendingTree. Average Credit Card Interest Rate in America Today. https://www.lendingtree.com/credit-cards/study/average-credit-card-interest-rate-in-america/.
4. Investopedia. Is Interest on a Home Equity Line of Credit (HELOC) Tax Deductible? https://www.investopedia.com/mortgage/heloc/tax-deductible/
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