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

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.

What is a HELOC and how does it work? 

A HELOC, or home equity line of credit, is a line of credit secured by your home. It’s a way to borrow against your home equity. You receive a credit limit and can borrow as needed during the draw period, then repay the balance, typically in monthly installments, during the repayment period.

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:

• Credit card refinancing

• Debt consolidation

• Home repairs and improvements

• Emergency expenses

• Medical expenses

• Large, planned purchases like new furniture or electronics

• Wedding expenses

What is the draw period? 

A HELOC’s draw period is the initial phase—usually lasting five to 10 years—when you can borrow, repay, and borrow again as often as you like, up to the maximum credit line. 

HELOC draw period example:

Let’s say you get a HELOC with a $100,000 limit, and you borrow the full amount when your loan closes. You pay the balance down to $70,000 and you’re still in your draw period. If you want to, you can borrow another $30,000. 

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 get a HELOC from a bank or credit union with a branch near you, you might also be able to withdraw cash in person.

How do HELOC payments work?

HELOC payments could fluctuate during the draw period if the balance goes up and down. 

Some HELOC lenders allow you to make interest-only payments during the draw period. You would pay only the interest on what you've borrowed, but nothing toward the principal. That means two things:

• Your payments will spike when you enter the regular repayment period. At that time, it’ll be a regular principal plus interest payment that’s big enough to pay off your loan by the end of your loan term.

• You won’t be able to borrow more once you hit your loan limit, even if you’re still in the draw period. Even years of payments won’t reduce your balance or free up any of your available credit if you’re only paying the interest.

Once your draw period ends and your repayment period begins, your monthly payment will be set to an amount that will fully pay off your loan by the end of the loan term.

If you get an Achieve Loan, you’ll make a principal plus interest payment from the time your loan closes. It will always be based on your balance and loan term. There won’t be payment shock the day your draw period ends.

Regular payments cover both interest and principal, with the proportion of each shifting over time. In the early days, more of the payment goes toward interest, but as the loan term progresses, a larger portion is applied to the principal. The advantage of a fully amortized loan is that you don’t have a lump sum due at the end of the repayment term.

What happens during the repayment period? 

The repayment period begins after the draw period ends. You can’t borrow more, and you’ll start repaying both the principal and interest in monthly installments. Depending on your lender and loan terms, this phase typically lasts five to 30 years.

At Achieve Loans, you can choose up to a 30-year HELOC repayment term that includes the draw period. A longer repayment period could get you a lower monthly payment, and a shorter repayment period helps you minimize the amount of interest you’ll pay. 

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

• How much you owe

• The repayment term

• Your interest rate

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 depends on:

• How much home equity you have

• The lender’s CLTV limit

• The lender’s loan limit

• Your financial picture

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. 

Here’s how to calculate your equity:

400,000 - 170,000 = 230,000

You have $230,000 in equity. 

Here’s how to calculate your loan-to-value ratio. That’s the amount you owe, compared to the home’s value:

170,000 / 400,000 = 0.425

Multiply the answer by 100 to get a percentage. Your LTV is 42.5%. 

Find out the lender’s CLTV limit and loan limit.

HELOC lenders limit how much total mortgage debt you can owe on your home. The combined loan-to-value ratio is the amount you will owe once you get the new loan, compared to the home’s value. 

If the lender’s CLTV limit is 80%, you can’t owe more than $320,000 on this home. That gives you some room to borrow with a HELOC. You could apply for a $150,000 HELOC and still be under the lender’s limit.

The lender’s loan limit is simply the most they will lend any borrower.

Last, review your credit and review your income and debts. Factors that could 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. The lender will want to be sure you have room in your budget for a new loan payment.

How do you know your home’s value?

You can get an idea of your home’s value by looking at real estate websites, but when it comes time to review your loan application, expect your lender to do their own appraisal. For HELOCs, many lenders find out the value of your home by using technology, not an in-person appraiser who visits your home. The technology is called Automated Valuation Software.

What is the interest rate 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. 

Here are the three types of interest offered by HELOC lenders:

• Variable-rate HELOCs. Most HELOCs have a variable rate. That means the interest rate could increase or decrease as the economy fluctuates. Budgeting for this kind of HELOC could be tricky because you won't know when the cost of borrowing will change.

• Hybrid HELOCs. With a hybrid HELOC, your lender may let you 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 will never change.

The last variety to mention is the similarly named home equity loan, which gives you a lump sum of cash upfront 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.

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.

Can you pay off a HELOC early?

Yes, you can pay off a HELOC early. The caveat is that some lenders charge a prepayment penalty. That’s a fee for paying off the loan ahead of schedule. Paying a HELOC early could be a good idea if you can afford it, because the faster you pay off a loan, the less interest you’ll pay. 

Pros and cons of a HELOC

Whether or not to take out a HELOC is a big decision, one with both pros and cons. For example:

Pros

• Lower interest rate. HELOCs are less risky for lenders compared to unsecured loans, so they tend to cost less. You could start off with a lower interest rate.

• Borrowing flexibility. You can borrow exactly what you need, with the option to borrow again up to your limit if your needs change.  

• Credit score boost. A HELOC is an installment loan. If you make all your payments on time, that could have a positive impact on your credit score.  

• Potentially tax-deductible. If you use HELOC funds to make improvements or repairs to your home, the interest you pay on the loan may be tax-deductible. 

Cons

• Variable interest rates. Some HELOCS have a variable interest rate, meaning the rate can change. If the rate goes up, so do your monthly payments. Achieve Loan HELOCS are fixed-rate. Your payments will never change. 

• House as collateral. With a home equity loan, your house is on the line if you fail to make payments as agreed. 

• Less equity. Borrowing against your home's equity means it isn't available until you pay down your loan balance. If you were to sell your home, the mortgage and HELOC would be paid off before you get any money from the sale.  

Is a HELOC a good idea? 

A HELOC can be an excellent idea for a borrower who has a clear idea of how the money will be used. For example, if you're considering a HELOC to rid yourself of high-interest debt, doing so could save you thousands of dollars in interest payments. If your home is in serious need of repairs and upgrades, each of those projects could improve your quality of life and possibly your home’s value. 

Ultimately, you must decide if the reason you're borrowing the money outweighs the potential risk. Asking yourself the following questions can help you make a solid decision:

• How's my emergency fund looking? Can I continue to make the HELOC payments if I lose my job or become ill?

• Do I have a clear plan for using the money and a clear plan for repayment?

• Am I using the money in a way that benefits me in the long run?

Home equity loan from Achieve Loans

One thing that sets an Achieve Loans home loan apart from the crowd is the fact that Achieve Loans HELOCs have a fixed interest rate. A fixed rate means your monthly payment amount won’t change. Also, a repayment term of up to 30 years could make it possible for you to tackle a very large expense, knowing you have enough time to pay it off in an affordable way. 

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.