Home Equity Line of Credit (HELOC)

A Home Equity Line of Credit, commonly abbreviated HELOC, is a revolving line of credit secured by the equity a homeowner has built up in their property. Unlike a traditional loan that disburses a fixed lump sum upfront, a HELOC works more like a credit card secured against a home: the homeowner is approved for a maximum credit limit and can borrow, repay, and borrow again up to that limit during a set period, known as the draw period, typically paying interest only on the amount actually drawn at any given time.

Because the home itself secures the line, HELOCs generally carry lower interest rates than unsecured loans or credit cards, but they also put the home at risk of foreclosure if the borrower fails to keep up with repayments, since the lender's security for the line is the same property the homeowner lives in.

A HELOC works similarly to a credit card, except the credit limit is determined by how much equity exists in the home rather than by income and credit score alone, and the home itself stands behind the promise to repay rather than the unsecured promise behind an ordinary credit card. A homeowner can draw funds for a home renovation, pay some of it back, then draw again later for a different need, all within the same approved credit line, rather than needing to apply for a brand new loan each time.

• During the draw period, typically 5 to 10 years, the borrower can draw funds as needed and generally makes interest-only payments on the outstanding balance.
• Once the draw period ends, the HELOC enters a repayment period, during which no further draws are permitted and the borrower must repay both principal and interest on whatever balance remains outstanding.
• The transition from interest-only draw-period payments to full principal-and-interest repayment-period payments can cause a significant jump in the required monthly payment, a detail borrowers are specifically advised to plan for in advance.

Lenders generally set a HELOC's maximum credit limit based on a percentage of the home's appraised value, minus any existing mortgage balance, resulting in an available loan-to-value figure the lender is willing to extend. HELOCs typically carry a variable interest rate tied to a reference rate, meaning the cost of borrowing can rise or fall over the life of the line, in contrast to a home equity loan, which usually carries a fixed rate and disburses a single lump sum rather than a flexible, reusable credit line.

Homeowners commonly use a HELOC to fund home renovations that may themselves increase the property's value, to consolidate higher-interest debt such as credit card balances into a lower-rate secured line, to cover large, irregular expenses such as education costs, or to maintain a flexible financial cushion that can be drawn on only if genuinely needed, with interest charged only on amounts actually withdrawn rather than on the full approved limit.

Because a HELOC is secured by the home and typically carries a variable rate, borrowers face two layered risks that a fixed-rate home equity loan does not combine in quite the same way: the risk of losing the home to foreclosure if payments are not kept up, and the risk that required payments rise unexpectedly if the underlying reference rate increases significantly during the draw or repayment period. Lenders generally also reserve the right to freeze or reduce a HELOC's available credit limit if the home's value declines significantly or the borrower's financial situation deteriorates, even if the borrower has never missed a payment.

Borrowers comparing a HELOC against other financing options should weigh its flexibility against its variable-rate exposure, since a line that looks inexpensive when first opened can become considerably more costly if interest rates rise meaningfully before the balance is repaid.

• Consumer Financial Protection Bureau