A HELOC is a second mortgage that lets you borrow against your home's value, and you draw money as you need it

A home equity line of credit (HELOC) is a loan secured by the equity you have built in your home. Unlike a traditional second mortgage where you borrow a lump sum upfront, a HELOC works like a credit card: the bank sets a credit limit based on your home's value and your equity, and you draw from that limit whenever you choose. You pay interest only on the money you actually use, not on the full credit line.

The process starts with your lender ordering an appraisal of your home to determine its current market value. They subtract what you still owe on your first mortgage, property taxes, and any other liens. The remaining amount is your equity. Most lenders will let you borrow 80 to 90 percent of that equity, though some go higher or lower depending on their risk appetite and your credit profile.

HELOCs typically have two phases: a draw period (usually 5 to 10 years) when you can borrow and repay repeatedly, and a repayment period (usually 10 to 20 years) when you can no longer draw new money and must pay back what you borrowed. Interest rates are usually variable, meaning they move with market conditions, though some lenders offer fixed-rate HELOCs or allow you to lock in a fixed rate on portions of your balance.

Key Takeaways

  • A HELOC requires a home appraisal, proof of income, and a credit check; most lenders want a credit score of 620 or higher and a debt-to-income ratio below 43 percent.
  • You can borrow up to 80 to 90 percent of your home's equity, but the actual amount depends on your income, credit history, and the lender's standards.
  • During the draw period you pay interest only on what you borrow; during the repayment period your monthly payment rises because you must repay principal plus interest.
  • Variable-rate HELOCs can become expensive if interest rates rise, so compare fixed-rate options and understand what your payment could be at a higher rate.
  • Your home is collateral, so if you stop paying, the lender can foreclose and force a sale to recover the debt.

What lenders examine before approving a HELOC

Banks and credit unions use a standard set of documents and metrics to decide whether to lend to you. The first is your credit report and score. Most lenders want a score of 620 or higher, though competitive rates usually require 700 or above. They pull your report from all three bureaus (Equifax, Experian, TransUnion) to check for late payments, collections, or recent inquiries that suggest financial stress.

Next is proof of income. If you are employed, you will need recent pay stubs (usually the last two months) and often a W-2 from the previous year. If you are self-employed, the lender will ask for two years of tax returns and possibly profit-and-loss statements. Some lenders also verify income directly with your employer by phone or through a third-party service.

The lender calculates your debt-to-income ratio by adding all your monthly debt payments (mortgage, car loans, credit cards, student loans, and the new HELOC payment) and dividing by your gross monthly income. Most lenders want this ratio below 43 percent, though some go to 50 percent for borrowers with strong credit and substantial equity. This ratio determines how much you can borrow.

Finally, the lender orders an appraisal of your home, usually costing $300 to $600. The appraiser inspects the property, compares it to recent sales of similar homes in your area, and produces a written estimate of market value. If the appraisal comes in lower than expected, your available credit line shrinks because your equity is lower.

How to calculate how much you can borrow

The math is straightforward once you know your home's appraised value and what you owe. Suppose your home appraises at $400,000 and you owe $250,000 on your first mortgage. Your equity is $150,000. If the lender allows you to borrow 85 percent of equity, your maximum HELOC is $127,500.

But your actual credit limit may be lower if your income cannot support the monthly payment. Lenders use a formula: they estimate what your payment would be at a higher interest rate (often 5 percent higher than the current rate) and check whether that payment, combined with all your other debts, stays within your debt-to-income limit. If your income is $5,000 per month and your other debts are $1,500, you have $1,650 left before hitting 43 percent. That limits how much the lender will let you borrow.

Different lenders use different equity percentages and income requirements, so the amount you can borrow varies. A bank might offer 85 percent of equity while a credit union offers 80 percent. Some lenders are stricter about debt-to-income ratios. Shopping with three to five lenders gives you a real picture of what is available to you.

The draw period: how you access the money

Once your HELOC is approved and funded, you enter the draw period. The lender gives you a checkbook, a debit card, or online access to request transfers to your bank account. You can draw all the money at once, a little at a time, or in between—it is entirely up to you. The credit line stays open as long as you keep the account in good standing.

During the draw period, you typically pay interest-only on the balance you have drawn. If you have a $100,000 credit line but have only drawn $30,000, you pay interest on $30,000. If interest rates are 7 percent, your monthly payment is roughly $175. If you draw another $20,000, your payment rises to about $292. If you pay back $10,000, your payment drops to about $210.

This flexibility is the main advantage of a HELOC over a traditional second mortgage. You can use it for a home renovation, pay off credit card debt, cover medical expenses, or fund a business—whatever you need. You only pay for what you use, and you can repay and redraw as often as you want during the draw period.

The repayment period: when your payment jumps

When the draw period ends, the HELOC enters the repayment period. You can no longer draw new money. Instead, you must pay back everything you borrowed, plus interest, over the remaining term (usually 10 to 20 years). Your monthly payment now includes both principal and interest, so it rises significantly.

This is where many borrowers get surprised. Suppose you drew $80,000 during the draw period and paid back $20,000, leaving a balance of $60,000. During the draw period at 7 percent interest, your payment was roughly $350 per month. When the repayment period begins, that same $60,000 must be repaid over, say, 15 years. Your new payment is roughly $475 per month—a 35 percent jump. If interest rates have risen, the jump is even steeper.

Some borrowers refinance into a new HELOC or a fixed-rate loan to avoid payment shock. Others convert their HELOC balance to a fixed-rate loan with the same lender. The key is to understand your repayment terms before you sign and to plan for the payment increase.

Fixed-rate versus variable-rate HELOCs

Most HELOCs come with variable interest rates tied to an index like the prime rate. When the Federal Reserve raises rates, your HELOC rate rises too, and your payment increases. When rates fall, your payment falls. This uncertainty makes budgeting harder, but variable rates start lower than fixed rates.

Some lenders offer fixed-rate HELOCs or let you lock in a fixed rate on part of your balance. A fixed rate is higher upfront but protects you if rates rise. If you plan to carry a large balance for years, a fixed rate or a partial fixed conversion may be worth the extra cost. If you plan to pay off the HELOC quickly, a variable rate is usually cheaper.

Before you commit, ask the lender what your payment would be if rates rose by 2 or 3 percentage points. If that payment would strain your budget, a fixed-rate option or a smaller credit line may be safer. Some lenders also cap how high your rate can go (a rate cap), which limits your worst-case payment.

Costs and fees to compare across lenders

HELOCs are not free to set up. Common costs include an appraisal fee ($300 to $600), a credit report fee ($25 to $75), an underwriting or processing fee ($300 to $500), and sometimes a title search or title insurance fee ($100 to $300). Some lenders waive these fees if you meet certain conditions, such as maintaining a minimum balance or setting up automatic payments.

Annual fees are less common but do exist at some institutions. A few lenders charge an inactivity fee if you do not draw money for a certain period. Some charge a fee to convert your variable rate to a fixed rate. Read the disclosure documents carefully—the Truth in Lending Act requires lenders to itemize all costs upfront.

When comparing HELOCs, ask for the total cost to open the account, the interest rate and how it adjusts, any annual or inactivity fees, and what happens at the end of the draw period. A HELOC with a slightly higher rate but lower fees may cost less overall than one with a lower rate and high upfront costs.

Frequently Asked Questions

Can I get a HELOC if I have bad credit?

Most lenders require a credit score of 620 or higher, and many prefer 700 or above. If your score is below 620, some credit unions and portfolio lenders (banks that keep loans on their own books rather than selling them) may still work with you, but you will pay a higher rate and may have a smaller credit line. Building your score before you explore usually results in better terms.

What happens to my HELOC if interest rates rise?

If you have a variable-rate HELOC, your interest rate and monthly payment rise when the prime rate rises. Your payment can increase by hundreds of dollars per month if rates climb significantly. Some HELOCs have a rate cap that limits how high your rate can go. If you are worried about rising rates, ask about fixed-rate options or plan to pay off the balance before rates spike.

Can the lender freeze or close my HELOC?

Yes. If your home value drops sharply, your credit score falls, or you miss payments, the lender can reduce your credit line or close the account entirely. During the 2008 financial crisis, many lenders froze HELOCs when home values plummeted. This is a real risk, so do not count on a HELOC as your only emergency fund.

What if I cannot pay back the HELOC during the repayment period?

If you cannot afford the repayment-period payment, you can try to refinance into a new HELOC, convert the balance to a fixed-rate loan, or work with the lender on a modified payment plan. If none of those work, the lender can foreclose on your home. Because a HELOC is secured by your house, defaulting puts your home at risk.

Is a HELOC better than a personal loan or credit card?

A HELOC usually has a lower interest rate than a personal loan or credit card because it is secured by your home. But that security cuts both ways: if you cannot pay, you lose your house. A personal loan or credit card does not put your home at risk, but the interest rate is higher. Use a HELOC only if you are confident you can repay and if the lower rate justifies the risk.