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.

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:

• Credit card refinancing

• Debt consolidation

• Home repairs and improvements

• Emergency expenses

• Medical expenses

• Large, planned purchases like new furniture or electronics

• Wedding expenses

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. 

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.