A home equity line of credit, or HELOC, is a loan that allows you to borrow against the equity you’ve built up in your home and functions almost like a credit card. It provides an open line of credit that you can access for a certain amount of time (typically 10 years). During that time, you’re only required to pay back the interest on money you’ve withdrawn, which means you can borrow a large amount of money for an extended period of time while only making minimum monthly payments.
HELOCs can be a good option in a rising interest rate environment like the one we’re currently in because they have lower rates than most credit cards, personal loans, home equity loans and mortgage refinances. But HELOCs are also risky because they’re secured loans, which require collateral to obtain financing: Your home serves as the collateral, so if you’re unable to pay back the money you’ve withdrawn, you could lose your house. In addition, HELOCs have variable interest rates that mean your rate can go up or down with the market, so you won’t always have a predictable monthly payment.
We’ll walk you through how a HELOC works, how to decide if it’s the right option for you and how it stacks up against other loan types.
Current HELOC rate trends
Right now, the average interest rate for a 10-year HELOC is around 5.5% and 7.3% for a 20-year HELOC, according to Bankrate, which is owned by the same parent company as CNET. Anything below the average rate is typically considered a good rate for HELOCs.
Interest rates for HELOCs are variable and largely determined by the benchmark interest rate, which is set by the Federal Reserve. So far this year, the Fed has raised the benchmark interest rate three times and has signaled it will continue raising rates throughout 2022. Interest rates for HELOCs tend to be lower than mortgage rates and other home equity loan rates, which is one of the benefits. They also usually have introductory periods during which they offer an even lower rate for a certain amount of time.
What is a HELOC?
A HELOC is a home loan that allows you to tap into your home’s equity over an extended period of time. You can find out how much equity you have in your home by subtracting your remaining mortgage balance from the house’s current market value. So if your house is worth $500,000 and you have $300,000 left to pay off on your mortgage, you would have $200,000 in equity. Typically you can borrow up to 85% of your equity — in this case, that’s $170,000.
A HELOC functions as a revolving line of credit that you can continually access. The time period when you can draw money from your line of credit is called the draw period, and it’s usually 10 years for HELOCs. This could be a good option if you need access to money, but aren’t sure how much you’ll need (or when you’ll need it). HELOCs also tend to have lower interest rates than other types of home loans or personal loans.
If you need cash for home improvements or to pay higher education costs like tuition, a HELOC can be beneficial because you can repeatedly withdraw money over the course of your loan term. Plus, you only have to pay interest on the money that you withdraw. So, if you’re approved for a HELOC of $100,000 and only withdraw $25,000, you’ll only pay interest on the $25,000.
How do HELOCs work?
Since HELOCs work like a line of credit, during the draw period you can take out money as many times as you need via check or a debit card, as long as it’s below your total HELOC loan amount. You must also make minimal monthly payments, typically just for the interest that accrues during the draw period. As you repay your HELOC, this money is added back to your revolving balance (so you can continue to withdraw funds).
Once the draw period comes to an end you enter the repayment period, which usually lasts between 10 to 20 years. At this point, you cannot take more money out of your HELOC. Once you’re in the repayment period, your monthly payments will go up because you must start paying back the principal (the amount you withdrew) in addition to the accrued interest.
Pros of a HELOC
- Lower interest rates: HELOCs typically have lower interest rates than other home equity loans, personal loans or credit cards.
- Long draw and repayment periods: Most HELOCs let you withdraw money for as long as 10 years, and then offer an even longer repayment period (usually up to 20 years).
- You can take the money in installments: You don’t have to use all of the money available at once, and you only have to pay interest on the funds you withdraw.
Cons of a HELOC
- You have to use your own home as collateral: If you default on a HELOC or can’t make your payments, you could lose your home. When you put a house up as collateral and cannot repay your loan, the bank or lender can foreclose on your home, which means they can take ownership of your house in order to make up for the money they lost.
- They have variable interest rates: Your initial interest rate may be low, but HELOC rates are variable and not fixed. This means they can fluctuate depending on what’s happening with the economy and the benchmark interest rate. This means your monthly payments are not predictable and can fluctuate over the course of the loan. While there are fixed-rate HELOCs, they are less common and are considered a hybrid between a HELOC and a home equity loan.
- There may be minimum withdrawal amounts: Some HELOCs have minimal initial withdrawal amounts, which could lead you to taking out more money than planned (and having to pay back more than planned).
HELOCs vs. home equity loans
HELOCs and home equity loans both allow you to borrow against the equity you’ve built up in a home. With both, you take out a second home loan in addition to your mortgage. Your home is also used as collateral to secure either type of loan. A home equity loan, however, offers a lump sum of cash that you pay back in fixed monthly installments. A HELOC, on the other hand, approves you for a set loan amount and then allows you to withdraw only what you need, when you need it.
A HELOC has a variable interest rate, whereas home equity loans are fixed-rate loans. This means, you’ll have a more predictable monthly payment with a home equity loan. HELOCs are much more flexible, but your monthly payments can be more unpredictable since your interest rate can fluctuate. With a HELOC, you need to make sure you can afford your monthly interest payments if your rate shoots up.
A HELOC is better if:
- You need access to credit for an extended period of time (usually 10 years)
- You need more time to repay the loan amount
- You want the flexibility to withdraw your money in installments and not all at once
A home equity loan is better if:
- You want a fixed interest rate
- You want a predictable monthly repayment schedule
- You want one lump sum of cash and know exactly how much money you need
HELOCs vs. cash-out refinances
A cash-out refinance is a different type of loan than a HELOC: You are quite literally cashing out the equity you’ve built up in your home over the years. It replaces your current mortgage with a new mortgage equal to your home’s value, and allows you to cash out the amount you’ve built in equity. If your home is valued at $300,000 and you still owe $100,000 on a mortgage, the difference of $200,000 is your home equity. Lenders often let you cash out 80% of your equity ($140,000 in this case).
With a HELOC, you’re also cashing out your equity, but you are taking out an additional loan alongside your current mortgage. So, you will have to make your monthly mortgage payments in addition to repaying your HELOC each month. With a cash-out refinance, you are only responsible for your mortgage payment every month. However, your mortgage payment will be more expensive because you added more money onto your mortgage when you cashed out your equity.
A cash-out refinance offers you this equity in a lump sum, whereas a HELOC lets you draw on your equity in installments and offers a yearslong line of credit.
A HELOC is better if:
- You need access to credit for an extended period of time (usually 10 years)
- You need a longer loan repayment period
- You want to the flexibility to withdraw your money in installments
A cash-out refinance is better if:
- You want to refinance your mortgage to a lower interest rate or shorter term
- You want one one lump sum of cash and know the amount
- You want one fixed monthly mortgage payment
What is a good HELOC rate?
Anything below the average rate is typically considered a good rate for HELOCs. Currently, the average interest rate for a 10-year HELOC is around 5.5% and 7.3% for a 20-year HELOC, according to Bankrate.
How do I qualify for a HELOC?
To qualify for a HELOC, you must have good credit, at least 15% to 20% equity in your home and a debt-to-income ratio that does not exceed 43%. (Your debt-to-income ratio is your total monthly debts divided by your gross monthly income.) So, if you make $4,000 a month before taxes and pay $1,500 in debts each month, your DTI would equal 37.5%. The lower your DTI, the better your approval chances.
If you have good or excellent credit, you could lock in a lower HELOC rate closer to 3% to 5%. If you have below average credit expect to pay rates closer to 9% to 10%. Lenders usually want to see at least a 620 credit score or higher. You can be denied for a HELOC if you don’t have a high enough credit score or income. You can also be denied if you don’t have enough equity built up in your home. Most lenders require at least 15% to 20%.
What can I use a HELOC for?
You can use your line of credit for almost anything, but HELOCs are typically best for people who need access to available credit over a long period of time or who will be making recurring withdrawals. For example, HELOCs are good for home improvement projects that could potentially take years or higher education expenses like tuition.
How do I apply for a HELOC?
You have to be approved for a HELOC by a bank or lender just like with your mortgage. You will need to provide financial documents like pay stubs and information about your home’s value, like your loan-to-value ratio. Lenders will also run a credit check before approving you.
In some cases, you may need to have your home appraised to confirm its current market value. It’s important to interview multiple lenders to compare rates and fees in order to find one who will give you the best rates. Some experts recommend starting with the bank or lender that already holds your mortgage, but shopping around can help you compare offers.
More mortgage tools and resources
You can use CNET’s mortgage calculator to help you determine how much house you can afford. The CNET mortgage calculator factors in variables like the size of your down payment, home price and interest rate to help you figure out how large of mortgage you may be able to afford. Using the CNET mortgage calculator can help you understand how much of a difference even a slight increase in rates can make in how much interest you’ll pay over the lifetime of your loan.