A home equity line of credit, usually shortened to HELOC, is a revolving loan that is secured by the equity you have built up in your home. "Revolving" means the lender approves a maximum borrowing amount, and you can draw on it, pay it back, and draw again, much the way a credit card works. The lender places a lien on the property, so the house itself is collateral. If the borrower stops paying, the lender can foreclose, the same legal process used when a purchase mortgage goes unpaid. That is the single most important fact to hold onto: a HELOC is not unsecured consumer debt, and the consequences of default are not the same as missing a credit card payment.
Home equity is the difference between what your home is currently worth and what you still owe on the mortgages recorded against it. A HELOC lets you borrow against that gap, up to a limit set by the lender. The limit is normally expressed as a loan-to-value ratio: if a lender will lend up to 85 percent of the home's value and you already have a first mortgage balance equal to 70 percent of value, the maximum HELOC you can draw is roughly the difference.
How a HELOC actually works
Most HELOCs are split into two phases. The draw period is usually five to ten years, during which you can borrow up to your credit limit, pay interest only, or pay some principal back. Once the draw period ends, the repayment period begins, often lasting ten to twenty years, and you can no longer draw new funds. From that point on, you pay back principal and interest in regular monthly instalments until the balance is zero. Some lenders offer a single combined term instead, with no separate draw window.
During the draw period many borrowers use a HELOC the way they might use the borrowing capacity described in our Credit Cards guide: a flexible pot of money for short-term needs, repaid in full when possible. The crucial difference is that the underlying credit is tied to home equity rather than to a credit limit set by income and credit history alone.
What decides what a HELOC costs
HELOCs almost always carry a variable interest rate. The rate is set by adding a margin to a benchmark index, commonly the prime rate published by reference banks. When the benchmark moves, the rate on your line moves with it, usually within a billing cycle. The cost to the borrower, expressed as the annual percentage rate (APR), is the rate plus certain finance charges rolled into a single figure so that competing offers can be compared on like-for-like terms. APR is the standard tool for comparing any loan, and our Loans overview explains the calculation in more depth.
Some lenders advertise an introductory rate that is lower than the fully indexed rate for an initial period, often six to twelve months. Once that teaser expires, the rate resets to the index plus margin. A small number of lenders offer a fixed-rate option, where you convert a portion of the balance into a fixed instalment loan, which can be useful for borrowers worried about rate increases during the draw period.
Other costs to watch for include an annual fee (often waived in the first year), a draw fee charged each time you take money out, and closing costs similar to those described in our Refinancing guide, although usually lower than for a full refinance. Some lenders refund closing costs if the line stays open for a set period.
How lenders decide how much to offer
Underwriting on a HELOC looks at three main ingredients: the appraised or estimated value of the home, the existing mortgage balance, and the borrower's income, debts, and credit profile. Lenders run a combined loan-to-value calculation that includes both the current mortgage and the new HELOC. A common cap is 85 percent combined LTV, though stricter or looser limits exist. Credit score, debt-to-income ratio, and employment history all affect whether you qualify and what margin you are offered above the index.
What to compare when shopping
- The index and margin. Two HELOCs at "prime plus 1 percent" and "prime plus 0.5 percent" behave very differently as rates change.
- The APR, not just the introductory rate. APR folds in most of the upfront charges.
- Draw and repayment terms. A ten-year draw with interest-only payments is very different from a five-year draw, even with the same rate.
- Fees and whether they are fixed or negotiable. Application, appraisal, annual, and draw fees can add up.
- Repayment terms and whether the balance can be recast. Some lenders allow a balloon payoff at the end of the draw period, which is rarely what a borrower wants.
- Minimum draw requirements. Some lenders require you to take an initial draw at closing.
Common traps
Variable rates can rise quickly. A payment that looked comfortable when the prime rate was low can double within a couple of years, especially in a rising-rate environment. Because HELOCs are commonly marketed for home improvements, debt consolidation, or as a financial backstop, borrowers sometimes treat the credit limit as cash on hand rather than as a loan secured by their house.
Another trap is using a HELOC to fund consumption that does not generate a return, such as paying for a wedding or a holiday. The same warning applies to using home equity to invest in volatile assets; the math only works if the return on the investment comfortably exceeds the borrowing cost, and even then, leverage amplifies losses as well as gains. Our Investing guide discusses the general risks of borrowing to invest.
Finally, do not confuse a HELOC with a home equity loan. A home equity loan is a single lump sum, repaid on a fixed schedule at a fixed rate; a HELOC is a reusable line. The mechanics of a home equity loan are closer to a small purchase mortgage, and our Purchase mortgages guide explains how amortising loans behave over time.
How a HELOC fits alongside other products
For short-term, lower-balance borrowing, a HELOC is often cheaper than an unsecured personal loan or a high-rate credit card balance, but only if the borrower repays promptly. For storing an emergency fund or a near-term savings goal, a high-yield Banking & Savings account paying a competitive annual percentage yield (APY) is a separate tool with a different purpose: APY is the standard measure of how much an account earns over a year, including compounding, and it has no direct relationship to the APR you pay on a line of credit. Some borrowers park an emergency fund in a savings account, then draw on the HELOC only if a real need arises, accepting the small carrying cost in exchange for liquidity. Others simply keep a HELOC open as a precautionary line and never draw on it; check whether the lender charges an annual fee for an unused line.
Whatever the use, treat a HELOC as secured debt, plan the worst-case payment at a higher rate, and compare offers on APR, fees, and term structure rather than on the headline rate alone. Protecting the home means sizing the line to a payment you could still make if rates moved sharply higher than they are today.
Because a HELOC is secured by the property, lenders typically require the borrower to carry homeowners insurance at least equal to the outstanding balance, and sometimes flood insurance in designated zones; our Insurance guide covers the general role of cover in protecting a household balance sheet.