HELOC meaning
A home equity line of credit (HELOC) is an "open-end" line of credit that lets you borrow repeatedly against your home equity. Equity is your home's value minus what you owe on your mortgage. It works more like a credit card than a regular loan: you have a credit limit, you borrow only what you need, and money you repay can be borrowed again while the line is open.
Because the line is secured by your home, the CFPB warns that if you fall behind or can't repay on schedule, you could lose your home.
How big is the credit line?
Lenders generally base the line on a percentage of your home's appraised value, minus what you owe on your mortgage. Each lender sets its own percentage.
Example: a $400,000 home, a $250,000 mortgage and a lender that allows 85% (an example figure): $400,000 × 0.85 − $250,000 = $90,000.
The two phases: draw and repayment
| Phase | What happens | Typical payment |
|---|---|---|
| Draw period | You can borrow up to your limit, often with special checks or a card. The CFPB gives 10 years as an example length. | Often a minimum based on the balance; some plans allow interest only |
| Repayment period | You can no longer borrow. You repay the balance, often over 10 to 20 years. | Principal plus interest, often much higher |
Some plans require the whole balance to be paid at once when the draw period ends. The CFPB calls that a balloon payment, and if you can't pay it, you could lose your home.
Variable rates
Most HELOCs have a variable rate made of two parts: an index (common ones are the U.S. prime rate and the Constant Maturity Treasury rate) plus a margin the lender adds. When the index moves, your rate and payment move with it, even if you don't borrow more. Some lenders let you convert part or all of the balance to a fixed rate, which is usually higher but predictable. Watch for introductory rates that are unusually low for a short period, such as six months.
Interest-only HELOCs and payment shock
Some plans let you pay only the interest during the draw period. That keeps payments low, but the balance doesn't go down. When the repayment period starts, the payment jumps because you now pay principal too. That jump is called payment shock.
Worked example
You draw $50,000 at 8% (an example rate) and pay interest only during the draw period.
| Situation | Monthly payment |
|---|---|
| Draw period, interest only at 8% | $333.33 |
| Repayment over 20 years at 8% | $418.22 |
| Repayment over 15 years at 8% | $477.83 |
| Repayment over 20 years if the rate rises to 9% | $449.86 |
The step from $333 to $418 is a 25% jump with no change in rate. A shorter repayment period or a higher rate makes it bigger. Try your own numbers with the HELOC calculator or the loan calculator.
First lien HELOC
Most HELOCs are second mortgages: they sit behind your main mortgage. A first lien HELOC is a line of credit in first position, usually used to replace or pay off the existing mortgage. The basic rules are the same as any HELOC: a variable rate, a credit limit tied to your equity, a draw period and a repayment period, and the lender's right to freeze or reduce the line. The trade-off is flexibility against predictability. Paying extra lowers the balance and the interest right away, but if you keep drawing, the debt on your home doesn't shrink, and every rate rise hits your whole housing debt, not just a small second loan. Compare it with a regular fixed-rate mortgage using the mortgage calculator.
Fees and fine print
- Possible costs: appraisal, application fee (which might not be refunded if you're turned down), closing costs such as title search and filing, and annual fees even if you don't use the line.
- Some plans require a minimum draw each time (the CFPB's example is $300) or a minimum balance.
- Lenders can generally freeze or reduce your line if your home's value falls or your finances worsen.
- You can cancel within three days of opening the account by telling the lender in writing.
Is HELOC interest tax-deductible?
Only if you itemize and the money is used to buy, build or substantially improve the home that secures the line, according to IRS Publication 936. Interest on HELOC money used for other things, such as paying off credit cards, isn't deductible as mortgage interest.
Sources: CFPB: What is a HELOC?; CFPB: What you should know about HELOCs (booklet); IRS Publication 936.
Every worked example on this page was checked with Calcist's own engine and an independent reference.