What is a home equity line of credit (HELOC)?

Home equity is the value a homeowner might build in their home over time. It’s defined by the difference between the current market value of a residence and what’s still owed on a mortgage. 

One way to tap into that value is with a home equity line of credit, or HELOC for short. A HELOC is a revolving line of credit that allows homeowners to borrow against the equity in their homes. But the loan isn’t without risk because under the arrangement, the home acts as collateral. 

What you’ll learn:

• A HELOC is a line of credit against the value of a home.

• HELOCs are a form of revolving credit and secured debt.

• Falling behind on HELOC payments could result in foreclosure.

• HELOCs might be used to pay for home improvements, repairs and more.

HELOCs are revolving lines of credit secured by the equity built in a home. They have a few common stages. But according to the Consumer Financial Protection Bureau (CFPB), plans have different requirements. 

Most HELOCs have variable interest rates, which can go up or down based on the prime rate. HELOCs are also a form of secured debt, with the home acting as collateral. That means borrowers who default are at risk of losing their home.

If you apply for a home equity line of credit, the lender might determine the current value of your home through an appraisal. The appraised value can inform the amount you can borrow. For example, it may be a percentage of this appraised value minus what you still owe on the home. Lenders may also use credit scores and debt-to-income (DTI) ratios and other factors to determine how much credit to extend and what interest rate to offer.

In addition to appraisal fees, the CFPB notes there may be an additional application fee and closing costs to pay for attorneys, title searches, mortgage preparation and filing, property and title insurance, and taxes.

Once a HELOC is approved, borrowers are typically issued special checks or a card to access funds. The time when the money is accessible is known as the draw period. And draw periods usually last for a fixed amount of time, such as 10 years. 

During draw periods, money can be borrowed and then repaid to restore how much credit is available. Depending on the terms of the HELOC, there might be minimum amounts required to make withdrawals.

But it’s helpful to be aware of potential fees that come with using a HELOC. Fees can vary by lender, but there could be prepayment penalties, annual fees or fees for inactivity.

Repayment terms for HELOCs may vary by lender. Some HELOCs require borrowers to repay part of the principal each month. Other HELOC plans may have an interest-only draw period. This means that, during draw periods, borrowers may only be required to make interest payments on the money they take out. 

At the end of the draw period comes the repayment period. Lenders may require borrowers to pay back the outstanding balance plus interest during this time. It may be in a balloon payment, where everything must be paid at once. Or repayment periods could stretch over many years. There may also be opportunities to renew the line of credit. 

If someone who has a HELOC decides to sell their home, they’ll probably be required to pay back the HELOC and interest before the sale can take place.

Many homeowners use a HELOC to make home improvements, using their home’s own equity to further boost its value. One reason this is a popular choice is that the interest paid on these upgrades is tax deductible up to a certain amount when funded using a HELOC. 

People may also use HELOCs for other reasons. A few examples:

• Debt consolidation

• Medical expenses

• Business expenses

• Wedding expenses

• Tuition costs

A home equity line of credit and a home equity loan (HEL) both let people borrow against the value of their homes. But they’re not the same. Here’s a breakdown of some possible differences between the two:

Like any debt, whether a HELOC is considered good or bad debt depends on the borrower, the lender and how the loan is managed. Here are a few potential pros and cons:

• You can withdraw money as needed.

• It may have a lower interest rate than other types of credit, thanks to collateral.

• You may only be required to pay interest and principal on the amount of money you use, not the full credit line amount.

• Variable rates can lead to increased interest payments over time.

• It may include additional fees, such as cancellation fees, annual fees, application fees, appraisal fees and closing costs.

• If you don’t make the payments, you risk losing your home.

A home equity line of credit gives you a flexible way to borrow against the equity built in your home, but it also carries certain risks. If you’re considering shopping for a home equity line of credit, be sure to read your lending agreement carefully to ensure you understand the costs of establishing the plan and the terms of repayment.

Whether you’re a globe-trotting adventurer, an avid foodie or someone who wants to earn cash back on everyday purchases, Capital One has a rewards card to fit your lifestyle.

• See whether you’re pre-approved for credit cards without harming your credit scores. 

• Explore travel rewards cards with unlimited miles you can actually use. 

• Earn unlimited 1.5% cash back on every purchase, every day, with a cash back rewards card. 

• Earn unlimited cash back on food and fun with a dining and entertainment rewards card.