What’s a HELOC? Everything you need to know about a Home Equity Line of Credit

If you own a home and are thinking about a major purchase – like a home renovation, new appliances or even consolidating your debt — a home equity line of credit (HELOC) can help you access the cash you need.

But what exactly is a home equity line of credit?

Here’s the short version: a HELOC is a form of credit that lets you borrow up to a set amount of money for a set period of time, based on the equity you’ve built in your home. You can access the money all at once or use smaller amounts whenever you need it.

In high-cost areas, tapping in to the credit you’ve built up in your home can be a smart way to borrow money for major purchases.

Here are some answers to common questions about getting and using a HELOC:

What’s a variable rate home equity line of credit (HELOC) compared to a fixed rate home equity loan?

Both a variable rate HELOC and a fixed rate loan can be used for your borrowing needs, including:

• renovating your home;

• consolidating debt;

• general cash management;

• making a big purchase; or

• an emergency fund.

Both involve borrowing money based on the equity you’ve built in your home. They also both tend to offer a lower interest rate than other types of loans, but they work a little differently:

A home equity loan is great for when you need up-front financing. It's a one-time lump sum of money you borrow that’s paid back monthly over a set period of time. It’s a fixed rate loan, which means the payment and interest rate are the same each month. At the end of the loan term the loan balance is paid in full.

A home equity line of credit is a bit more flexible. It lets you use your credit as you need it over a set period of time called the draw period — typically 10 years followed by a repayment period up to 20 years. The HELOC has a variable interest rate, which means the rate and payment may change over time.

During the draw period you can choose to borrow the funds all at once or a little at a time, and you’ll only pay interest on the amount you actually borrow. You can also repay your balance at anytime and have the credit available to use again and again. Plus, with some HELOCs you can choose to lock in a portion of your loan at a fixed rate and have a fixed monthly payment plan. During the 20-year repayment period, you will repay principal and interest on the outstanding balance.

How can I use a HELOC?

HELOCs are a flexible way to get the funds you need, no matter your goals. Here are just some of the ways you can use a HELOC:

• Renovate your home: Make your home more enjoyable and valuable, by investing in the right home improvement projects.

• Consolidate your debt: Simplify your debt by consolidating your higher interest debts into one monthly payment.

• Make a big purchase: Get the funds you need for tuition expenses, a new car, or whatever else you need.

• Have an emergency fund: Be prepared for unexpected expenses, like a new roof or sump-pump, with a line of credit that lets you use it when you need it.

• General cash management: A HELOC is a nice tool to have in your back pocket to manage your finances when anything unexpected arises.

How much can you borrow with a HELOC?

A good rule of thumb is that, depending on your lender, you can typically borrow up to 80% or more based on the appraised value of your home, minus the amount you owe on your first mortgage.

Say your home is worth $300,000. Multiply that by 80%, then subtract what you still owe. For this example, we’ll say that’s $100,000. 80% of $300,000 is $240,000, then by subtracting the $100,000 that you still owe would mean that you have $140,000 to potentially borrow.

Total worth of home $300k × 80% − What is still owed $100k = Borrowing potential $140k

What are the interest rates or fees for a HELOC?

Because you are securing your line of credit based on the equity you’ve built in your home, the interest rate is often lower than with other types of loans.

HELOC interest rates can vary by location, so for example, your  HELOC interest rate in Illinois may differ from the rate of someone living in Florida.

During the draw and repayment periods, your HELOC interest rate is variable and your monthly payments can fluctuate over time. Before you sign on the dotted line, make sure to read all the borrowing terms, including how your interest rate will adjust and the lifetime cap (how high the interest can go during the length of the HELOC).

As for fees, you may need to pay closing costs. Some HELOCs may also require an annual fee or other participation and transaction fees.