Home Equity

Home equity line of credit: What to know

By
Social Links for Christopher Murray ,
reviewed by
Mike Schmidt,
edited by
Maddie Lloyd
Updated June 29, 2023, 8:21 p.m. ET
Toy stacks of money sit on piles of coins.
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Home equity is the difference between your home’s current market value and the amount you still owe on your mortgage. Loan products, such as a home equity line of credit (HELOC), allow you to tap into that difference and use the money for a variety of purposes.

A HELOC is a loan that’s secured by your home. It functions much like a credit card, where your home equity serves as a revolving line of credit that you can draw from as needed. You can use the funds from a HELOC to pay for home improvements, consolidate debt, or even to finance a large purchase.

What is a HELOC?

A HELOC is a revolving line of credit secured with your home as collateral. You can borrow from it as many times as you want during the borrowing, or “draw” period, which typically lasts for 10 years. Like a credit card, you’ll borrow up to a set credit limit and repay the balance repeatedly until the draw period ends.

When the draw period ends, you’ll enter the repayment period where you’ll make regular principal and interest payments until your balance is fully paid off, usually over 10 to 15 years. HELOCs tend to have variable interest rates (rather than a fixed interest rate), meaning how much you owe each month can fluctuate over time.

Borrowing limits for HELOCs are typically up to 80% of the equity in your home. You can use a HELOC to pay off big expenses like a home renovation or a wedding, or you can use it to cover smaller costs like a car repair.

How to qualify for a HELOC

In addition to having equity in your home, you’ll also have to meet eligibility criteria to qualify for a HELOC with most lenders.

“Qualifying for a line of credit is very similar to a conventional mortgage. The key elements are debt-to-income ratio (generally 43% is a hard ceiling, some banks will be more conservative), equity, and credit score,” says Casey Fleming, a Mortgage Advisor from Silicon Valley Mortgage. “HELOCs tend to be underwritten a little more conservatively than conventional loans, but if you qualify for a conventional loan and have equity in your home, you probably will qualify for a HELOC,” Fleming says. 

To get a HELOC, you’ll generally need to meet the following requirements:

  • Proof of income and employment: Lenders want to make sure that you earn enough to cover your monthly payments. You’ll likely have to provide pay stubs, W-2s, tax returns, and bank statements.
  • Debt-to-income (DTI) ratio: Your debt compared to your gross monthly income needs to be under a certain level. Lenders typically prefer a DTI under 43%, but some require a DTI no higher than 36%. 
  • Credit score: Minimum credit score requirements vary among lenders. Most lenders require a score of 620, but some require a score closer to 700. 
  • Sufficient home equity: To qualify for a HELOC, lenders will typically require that you have 15% to 20% equity in your home.

How to get a HELOC

If you’re ready to get a home equity line of credit, follow these steps:

  1. Calculate how much equity you have in your home. The first thing you’ll need to do is determine if you have enough home equity to qualify. Subtract your mortgage balance from your home’s appraised value at the time of purchase. You’ll need at least 15% to 25% equity to qualify for most HELOCs.
  2. Shop around and compare lenders. Not all lenders offer home equity lines of credit, but you can typically get a HELOC from banks, credit unions, and online lenders that offer credit lines or home loans. Make sure to compare annual percentage rates (APRs), loan terms, and eligibility criteria to find the right loan for you.
  3. Gather the necessary documents. This includes paperwork like pay stubs, tax returns, and bank statements.
  4. Submit the application. Once you’ve decided on a lender, you’ll need to complete an application. You can typically do this online, but if you opt for a bank or credit union in your area, you can fill out the application in person.
  5. Close on your loan. As with any home loan, you’ll have to pay closing costs on your HELOC. These fees tend to amount to 2% to 5% of your borrowing amount. When you close on your loan, you’ll pay any fees, sign closing agreements, and open your line of credit.

What can you use a HELOC for?

With a HELOC, you can borrow up to a pre-approved amount and use the credit line for a variety of needs. Here are just some of the ways you can use a HELOC:

  • Home improvement: A HELOC provides the necessary cash to do renovations or make repairs to your home. This can boost the value of your home and, in turn, increase your home equity.
  • Debt consolidation: You can use the funds from your HELOC to pay off existing debt, such as credit card debt or student loans.
  • School-related expenses: Whether it’s tuition, textbooks, or supplies, a HELOC can help cover the costs of school for you or your child.
  • Medical costs: You can use a HELOC to cover medical costs your health insurance doesn’t cover.
  • Business expansion: From funding equipment, renovating your property, or hiring employees, a HELOC can help you with that, too. 
  • Fund large expenses: If you’re planning a wedding or vacation and need some extra funds, you can use your HELOC to help cover these costs. 

Frequently asked questions

What’s the difference between HELOCs and home equity loans?

While HELOCs and home equity loans share a few similarities, they do have their differences. A HELOC is a variable-rate revolving line of credit based on the equity of your home. A home equity loan, on the other hand, is a fixed-rate loan, which is usually paid in installments over a set period of time.

How long will my HELOC last?

The length of your HELOC will depend on the terms of your loan agreement. Generally, HELOCs have an initial draw period, typically five to ten years, during which you can draw on the credit line and make interest-only payments. After this period, you’ll begin paying back the principal and interest. The repayment period is usually ten to twenty years.

Are there closing costs associated with a HELOC?

Yes, there are closing costs associated with HELOCs. Closing costs typically include an appraisal fee, title insurance, origination fee, and other administrative costs. The amount of these fees will vary depending on the lender and the loan size but typically range from 2% to 5% of your borrowing limit.

Are HELOCs tax deductible? 

Yes, HELOCs are generally tax deductible if the funds are used to purchase, build, or substantially improve the home that secures the loan. 

What’s the difference between a HELOC and a cash-out refinance?

A HELOC is a revolving line of credit secured by your home. It gives you the flexibility to borrow money up to a certain limit as you need it. A cash-out refinance is when you refinance your mortgage for more than the outstanding balance and receive the excess in cash at closing. This also allows you to access the equity you’ve built in your home.