How a HELOC Works
A Home Equity Line of Credit works like a credit card secured by your home. You get approved for a maximum credit limit based on your equity, then draw from it as needed. You only pay interest on what you actually borrow, not the full limit.
The Two Phases
- Draw period (5-10 years) — You can borrow, repay, and borrow again up to your credit limit. Most lenders require interest-only minimum payments during this phase
- Repayment period (10-20 years) — The credit line closes. You repay the outstanding balance with principal and interest payments. Monthly payments often increase significantly when this phase begins
HELOC vs Home Equity Loan
A HELOC gives you a revolving credit line with variable rates — ideal for ongoing expenses like home renovations where costs come in phases. A home equity loan gives you a lump sum with a fixed rate and fixed payments — better for one-time needs like debt consolidation. HELOCs offer flexibility; home equity loans offer predictability. Many homeowners choose based on whether they need the money all at once or over time.
HELOC Rates and Costs
HELOC rates are almost always variable, tied to the prime rate plus a margin set by your lender. When the Federal Reserve raises rates, your HELOC payment goes up. When rates fall, your payment decreases.
- Variable rate — Prime rate + 0.5% to 2% margin, depending on credit score and lender
- Rate caps — Most HELOCs have lifetime rate caps, typically 18%, and some have periodic caps limiting how much the rate can change per adjustment
- Closing costs — Some lenders waive closing costs; others charge 2-5% of the credit limit for appraisal, title search, and origination fees
- Annual fee — Some lenders charge an annual maintenance fee, while others waive it
Tax Deductions
HELOC interest is only tax deductible when the borrowed funds are used to buy, build, or substantially improve the home securing the loan. Renovations like a kitchen remodel or new roof qualify. Using HELOC funds for a vacation, tuition, or debt consolidation means the interest is not deductible.
HELOC Risks You Must Understand
Your home is collateral. If you cannot make payments, the lender can foreclose. Variable rates mean your payment can increase unexpectedly. Lenders can freeze or reduce your credit line if home values drop. Overborrowing during the draw period leads to payment shock when the repayment period begins. Only borrow what you can repay even if interest rates rise by 2-3%.