What is a HELOC (also known as a Home Equity Line of Credit)?
What is a HELOC?
According to the Consumer Financial Protection Bureau: a home equity line of credit (HELOC) is an "open-end" line of credit that allows you to borrow repeatedly against your home equity. Unlike a home equity loan (which is a "closed-end" line of credit that gives you a lump sum of money up front with a fixed repayment date), a HELOC let's you "draw" smaller chunks of money over a period of time (called the "draw period") until the "repayment period" begins. A common draw period is 10 years.
During the draw period, you can withdraw funds as needed and you'll be required to pay a minimum monthly amount on your balance which often consists of interest-only. However, once the draw period ends and the repayment period starts, you can no longer withdraw funds and your payments are going to be significantly higher because you'll be on a set schedule to repay the full balance. A typical HELOC repayment period is 10 or 20 years, but some HELOCs might requre you to pay the full balance all at once, so make sure you understand your HELOC options before opening one.
How much can I borrow through a HELOC?
A HELOC lets you borrow a percentage of the appraised value of your home, minus the amount you owe on your mortgage. This is called "home equity." When the housing market is booming, your home equity will be very high. However, if the value of your home decreases significantly over time, your lender might decide not to allow you to take out additional funds through your HELOC.
A HELOC is secured by your home (you could lose it!)
Only consider a HELOC if you’re confident you can keep up with the loan payments. If you fall behind or can’t repay the loan on schedule, you could lose your home! Before you decide to get a HELOC, we recommend you read the CFPB's What you should know about HELOCs guide.
What is the HELOC "draw period" ?
Once you're approved for a HELOC, you won't get a lump sum of money. Instead, you enter the draw period: a period of time (5 or 10 years is common) during which you can withdraw funds from your line of credit however you see fit. Your lender will commonly give you special checks or a credit card for the purpose of drawing on your credit line. Some HELOCs might have a minimum draw amount, like $300 - $500 each time. Some HELOC plans might require that you take an initial amount, but many do not require you to take draws.
Making payments during the draw period
During the draw period, you'll have minimum monthly payments on your HELOC based on your current balance. Lenders typically require you to make interest-only payments during the draw period. If you only pay interest, then you aren't reducing the principal balance on your HELOC, whereas if you pay more than just interest, you will be replenishing the amount that you can borrow from again. For example, if you drew $1000 from your HELOC and paid back the full $1000 plus interest a month later, then you can borrow that same $1000 again.
What is the "repayment period" of a HELOC?
Once the draw period ends, your HELOC transitions into the repayment period and you can no longer draw money from it. During the repayment period, you have to repay the total amount of money you borrowed from the HELOC. Usually your lender will set a repayment schedule of 10 to 20 years to pay it off, however in some cases you may actually need to make a full or partial payment all at once, called a "balloon payment" on your HELOC balance when you enter the repayment phase. Be sure to know the terms of your HELOC loan before opening it.
Monthly payments are often significantly higher once you enter repayment. Some HELOCs have a fixed interest rate during the repayment period, while others have a variable interest rate, which means your payments may change from month to month. This can cause uncertainty and be challenging for borrowers, so some HELOCs let you convert your balance from a variable rate to a fixed rate. Usually this fixed rate is higher than the variable rate but it's more predictable and consistent.
Are there fees and costs to opening a HELOC?
Some lenders offer HELOCs and will waive all or most of the up-front costs, while others may charge you fees to cover certain items:
- An application fee
- Closing costs (origination fee, appraisal fee, title fee, or other fees when you open an account)
- Annual fees - a fee each year you have the HELOC
- Inactivity fees – a fee for not using your HELOC
- Cancellation fees – a fee for terminating your HELOC early (usually within the first 2-3 years)
Repayment strategies for your HELOC
You might get used to the lower interest-only payments required during the draw period of a HELOC. You might also give in to the temptation to draw more funds than perhaps you should. As you approach the repayment period, the reality of much higher monthly payments on the horizon begins to kick in. Fortunately, there are some strategies that could help alleviate the burden of the approaching repayment period.:
- Cash-out refinance mortgage - You refinance your current mortgage by taking out a bigger mortgage. You use the difference as cash to pay off your HELOC
- Home equity loan - You open a home equity loan to pay off the HELOC
- Another HELOC - You open another HELOC to payoff the old one. Since you'll be starting a brand new draw-period, your minimum payments will be lower
Before applying for a HELOC, consider advice from a credit counselor
Before taking out a home equity line of credit / HELOC, you may want to consider speaking with a qualified credit counselor to help you weigh your options. Read about credit counseling at ConsumerFinance.gov.