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Home Equity Loans

Understanding the mechanics of a HELOC: how a home equity line of credit works

Nov 21, 2023

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Written by

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Reviewed by

Key takeaways:

  • A home equity line of credit could give you access to cash when you need it.

  • HELOCs are a second mortgage, secured by your home.

  • Even with equity, you need to meet a lender's underwriting requirements to qualify for a HELOC.

Becoming a homeowner is a major milestone, and the benefits don't end when you cross the threshold. Under the right circumstances, you can use your home as a tool to reach other financial goals. In fact, once you crunch the numbers, you might find that turning your home equity into spendable cash is the smartest of all your borrowing options.

A home equity line of credit (otherwise known as a HELOC) is one way to consolidate high-interest debts or cover a large expense. Let's take a look at what it is, how to get one, and how it works once you're approved.

HELOC basics

What is a home equity line of credit? A HELOC is a line of credit secured by your home. Secured loans are guaranteed by something valuable—in this case, your home. That's an advantage because home loans tend to have lower interest rates than other kinds of loans. Just know that with any secured loan, if you don't repay it, you could lose the thing you used as a guarantee—in this case, your home. 

You can think of a HELOC as being like a credit card. You can borrow against your approved limit, make payments toward the balance, and borrow again during the draw period.

What you can use a HELOC for is completely up to you—a home equity line of credit is a flexible way to borrow. Some of the most common uses for a HELOC include:

Types of HELOCs

There are different varieties of HELOCs out there. Generally, HELOCs fall into one of three categories. 

  • Variable-rate HELOCs. Most HELOCs have a variable rate. That means the interest rate can go up or down as the economy fluctuates. It can be hard to budget for this kind of HELOC because you won't know when the cost of borrowing changes.

  • Hybrid HELOCs. With a hybrid HELOC, your lender may lock in a fixed rate on part of the loan. The rest of your balance may have a variable interest rate or a different fixed rate. It would be up to the lender to determine which portions of your loan get which rate. These HELOCs have an element of unpredictability and can be pretty confusing. 

  • Fixed-rate HELOCs. A fixed-rate HELOC has an interest rate that's locked in when you're approved and remains the same for the entire life of the loan. During the repayment period, your payment amount won't change.

The last variety to mention is the similarly named home equity loan, which gives you a lump sum of cash up front instead of access to a credit line. Home equity loans usually have a fixed interest rate, but borrowing is less flexible compared to a HELOC. You have to take the full amount of the loan when the loan is funded, and you can't later decide to borrow more without applying for a whole new loan.

The HELOC draw period: using your credit line

HELOCs have an initial draw period in which you can access your credit line. During this period, often 5 to 10 years, you can withdraw funds up to your credit limit, hence the name. 

When it comes to spending the money, lenders usually offer borrowers a few options:

  • Paper checks

  • Debit cards

  • Credit cards

  • Electronic transfers directly to your bank account

If you're getting a home equity line of credit from a bank or credit union with a branch near you, you might also be able to withdraw cash in person. 

Homeowners, get help with your high-interest debt

Use the equity in your home to consolidate debt, lower your monthly payments, and reduce your stress.

How much can you borrow with a HELOC?

One of the questions most people ask about home equity loans is how much you can borrow

The answer largely depends on how much home equity you have. Home equity is the difference between your home's market value and the amount you still owe on your mortgage if you have one. If your home is currently worth $200,000 and your mortgage balance is $110,000, you have $90,000 in equity.

Lenders typically limit the amount of mortgage debt you can have against one property. A HELOC is typically a second mortgage. (It could be a primary mortgage if you don't already have a mortgage on the home.) The loan limit includes the amount you owe on your mortgage plus the new HELOC that you want. Here's what it might look like:

Let's say your home's current market value is $400,000 and you owe $170,000 on your mortgage. You have $230,000 in equity, or 57.5%. The opposite of equity, and what lenders look for, is your loan-to-value ratio (LTV). Here, your LTV is 42.5% (it means you still owe 42.5% of your home's value). If your HELOC lender's LTV limit is 80%, your total mortgage debt could be up to $320,000. That means you could potentially qualify for a $150,000 HELOC. 

$170,000 first mortgage + $150,000 HELOC = $320,000 total mortgage debt. 

Your lender will likely require a valuation report to determine how much your home is worth. Also, most lenders have a minimum and maximum loan amount. 

Other factors that can affect your HELOC amount include your credit profile and your debt-to-income (DTI) ratio. DTI is how much of your income you spend on debt and housing each month.

Interest on a HELOC

The interest rate on a HELOC is often lower than the rate you would pay to borrow with a credit card or a personal loan. That's because a HELOC is a secured loan, which lowers the risk for the lender. 

Some HELOC lenders allow you to make interest-only payments during the draw period. You only pay interest on what you've withdrawn so far, but nothing toward the principal. That changes once you enter the repayment period at the end of the draw period. 

Interest-only payments can be problematic because your monthly payment amount could spike sharply when you enter the regular repayment period.

Pro tip: Interest paid on a home equity line of credit might be tax-deductible if you use the money for improvements or repairs to your home. Starting in tax year 2026, the interest may be tax deductible no matter how you use the loan. Check with a tax professional.

HELOC repayment

Once the draw period ends, you can't borrow any more against your credit limit. You enter the repayment period, when you pay back your outstanding balance, with interest, in equal monthly payments.

How long the repayment period lasts can vary, and might be as long as 20 or 30 years. At Achieve, you can choose a 10 or 15-year repayment term that includes the draw period. You'll start making monthly principal and interest payments on the amount borrowed as soon as you borrow against your HELOC.  A longer repayment period can lower your monthly payment, but you'll pay more interest overall. 

Your monthly payment amount depends on a few factors, including:

  • How much principal you have to repay

  • The repayment term

  • Your interest rate, and whether it's fixed or variable

What's next 

  • Check your credit. Review your credit reports for errors you can correct or to find other moves you can make to improve your credit standing.   

  • Check your mortgage balance and estimate your home's value. You need equity to get a HELOC, so if you don't know what you owe on your home or what it's worth, find out.

  • Prequalify and compare rates. Get prequalified to compare HELOC rates. Be sure the lenders you check will prequalify you using a soft credit check that doesn't impact your score. 

Author Information

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Written by

Rebecca is a senior contributing writer and debt expert. She's a Certified Educator in Personal Finance and a banking expert for Forbes Advisor. In addition to writing for online publications, Rebecca owns a personal finance website dedicated to teaching women how to take control of their money.

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Reviewed by

Betsalel is a contributing writer for Achieve. Passionate about helping people improve their finances. He worked in mortgage banking, private banking, and personal financial coaching. When he is not working, he loves running and spending time with his family.

Frequently asked questions

HELOCs can range from $5,000 to $1,000,000 and more, and each lender sets its own minimum and maximum loan amount, unless limited by state law. Achieve offers amounts ranging from $15,000 up to $150,000, unless limited by state law. The amount of money you can get depends on the lender's requirements and terms. Many lenders will approve a HELOC for up to 80% of your home's value, including what you owe on any first mortgage. 

A 10-20 HELOC has a 10-year draw period followed by a 20-year repayment period. During the draw period, you can borrow, repay, and borrow more, up to your credit limit. Once the repayment period begins, you'll make equal monthly payments until the loan is paid off.

 

 

Both HELOCs and home equity loans allow you to borrow against your home's equity. A HELOC is a line of credit, similar to a credit card. You can borrow, repay, and borrow more, up to your credit limit during the draw period. A home equity loan is a lump sum loan. You get the funds all at once, when the loan funds. 

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Home Equity loans are available through our affiliate Achieve Loans (NMLS ID #1810501), Equal Housing Lender. All loan requests are subject to eligibility requirements, application review, loan amount, loan term, and lender approval. Product terms are subject to change at any time. Offers are a line of credit. Loans are not available to residents of all states and available loan terms/fees may vary by state where offered. Line amounts are between $15,000 and $300,000 and are assigned based on product type, debt-to-income ratio, and combined loan-to-value ratio. Minimum 640 credit score applies for debt consolidation requests, minimum 700 applies for cash out requests. Other terms, conditions and restrictions apply. Fixed rate APRs range from 8.75% - 15.00% and are assigned based on underwriting requirements; offer APRs include a .50% discount for automatic payment enrollment (autopay enrollment is not a condition of loan approval). Example: average HELOC is $57,150 with an APR of 12.75% and estimated monthly payment of $951 for a 15-year loan. 10, 15, 20, and 30-year terms available (20 and 30 year terms only available for cash out requests). All terms have a 5-year draw period with the remaining term being a no draw period. Payments are fully amortized during each period and determined on the outstanding principal balance each month. Closing fees range from $750 to $6,685, depending on line amount and state law requirements and typically include origination (3.5% of line amount) and underwriting ($725) fees if allowed by law. Property must be owner-occupied and combined loan-to-value ratio may not exceed 80%, including the new loan request. Property insurance is required and flood insurance may be required if the subject property is located in a flood zone. You must pledge your home as collateral. Contact Achieve Loans for further details. Monthly savings claim is based on average monthly debt savings from originated loans for 2023. Monthly savings varies based on each loan situation and can be more or less than $800.

Affiliated Business Arrangement Disclosure: Achieve.com (NMLS #138464) and Achieve Loans are both wholly owned subsidiaries of Achieve Company. Because of this relationship, your referral to Achieve Loans may provide Achieve.com a financial or other benefit. Where permitted by applicable state law, Achieve Loans charges: 1) an origination fee of 3.50%, and 2) an underwriting fee of $725. You are NOT required to use Achieve Loans for a home equity line of credit. Please click here for the full Affiliated Business Arrangement disclosure form.

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