HELOC: What It Is and How It Works

A home equity line of credit, or HELOC, allows you to borrow money using your home equity as collateral. HELOC’s are variable rate loans with interest-only payments.

A home equity line of credit (HELOC) is a form of credit that uses your home equity as collateral.

A HELOC can help you make major purchases or consolidate debt, often at a lower interest rate than you’d pay using a credit card or personal loan.

Falling behind on HELOC payments could result in losing your home, so have a sound repayment plan before using this type of loan.

What is a HELOC?

A HELOC loan is a secured, revolving form of credit. “Secured” means that the loan is backed by your home; if you miss payments, your lender can take possession of your home. “Revolving credit” means that you can borrow up to the limit, but you don’t need to tap it all at once. For instance, you could borrow a fraction of the limit to renovate a bathroom, and, the next year, you could borrow an additional amount to buy a boat. Credit cards are another example of revolving credit.

HELOCs vs. home equity loans

A HELOC and a home equity loan are similar in that they both use home equity as collateral. But they have some key differences:

	Home Equity Line of Credit	Home Equity Loan
How and when you access funds	You only access funds as you need them, and you don’t need to access the full amount at once. This is also called revolving credit — similar to a credit card.	You receive the full amount of your loan at once.
Also called.	HELOC.	Second mortgage.
Maximum amount you can borrow.	65% of your home’s value.	80% of your home’s value minus the amount of your outstanding mortgage.
Type of interest rate.	Variable rate only.	Variable or fixed rates.
Can you borrow more after paying back what you borrowed?	Yes.	No, you’ll need to apply for another home equity loan.

How a HELOC works

Like most credit products, you’ll have to apply for a home equity line of credit.

To qualify, you’ll need equity in your home. Most lenders want you to have at least 20%. You’ll also need to provide:

Proof of homeownership and mortgage details.
Evidence of stable employment and a consistent income.
An appraisal of your home’s current value.
An adequate credit score.
Manageable debt levels.

You’ll also be required to pass the same stress test lenders use when reviewing primary mortgage applications.

How much HELOC cash can you get?

If your HELOC is combined with a mortgage, you can access a maximum of 65% of the property’s market value. But your outstanding mortgage balance combined with your HELOC can’t exceed 80% of the value of your home.

HELOC rates

HELOC interest rates often consist of a lender’s prime rate plus a fixed percentage. For example, if your HELOC interest rate is prime + 2%, and your lender’s prime rate is 6%, the rate on your HELOC would be 8%.

Compared to credit card rates, which can be 19.99% or more, HELOCs tend to have favorable rates.

HELOC rates are typically variable, which means they fluctuate based on the Bank of Canada’s overnight rate. Whenever the overnight rate increases or decreases, lenders’ prime rates move the same amount in the same direction.

In some circumstances, you can negotiate a lower HELOC rate. In addition to demonstrating a strong, stable financial picture, you can share HELOC rate quotes you’ve received from other lenders. It’s also a good idea to check with lenders or financial institutions you already have a relationship with — they may be more flexible to retain your business.

HELOC fees

When getting a HELOC, you can expect to pay the following:

Legal fees for registering the collateral charge on your home.
Title search fees.
Application fees.
Home appraisal fees.
An origination fee.
Taxes.
A credit insurance fee.

These fees can add up to thousands of dollars and are one of the reasons that arranging a HELOC is often more complicated and expensive than setting up an unsecured line of credit.

Home equity line of credit combined with a mortgage

A home equity line of credit combined with a mortgage is the most common type of HELOC. Most Canadian lenders offer this type of HELOC.

The mortgage portion is a standard home loan; you’ll make regular payments that go toward both the principal and interest. The HELOC portion doesn’t typically have a fixed payment schedule, and minimum payments are based only on interest (although you’ll also need to pay off the principal, otherwise interest will continue to accrue).

As you pay off your mortgage, your equity increases. As a result, your lender can also increase the amount you can borrow with your HELOC. However, the value of a home is never guaranteed, and if the value of your home drops, your lender can reduce your line of credit.

Nerdy Tip: Some lenders brand HELOCs using different names or terms — “Homeline Plan,” for example.

Stand-alone home equity line of credit

A stand-alone home equity line of credit doesn’t include a mortgage. It’s simply a revolving line of credit guaranteed by your home. Since this HELOC is not tied to your mortgage, your borrowing limit won’t automatically rise as you pay down your mortgage principal.

Your borrowing limit is based on the amount of home equity you have when you apply for the HELOC, though lenders can adjust it in the future as your equity and your home’s value change.

Accessing and paying off a HELOC

With a HELOC, you’re not borrowing a single lump sum upfront. Instead, you’re opening a revolving line of credit that you can tap into as you choose. How much you use and when you decide to access it is up to you.

When paying back your HELOC funds, you’re required to make minimum monthly payments, which are interest-only. But, like paying only the minimum amount on credit card debt, paying only the interest on a HELOC is costly in the long run. Any unpaid principal will continue to rack up interest charges until it’s paid in full. You can pay off the principal in a single lump-sum or over time like you do with your mortgage.

A HELOC can provide access to much-needed funds, but it’s best to have a plan to repay the entire amount before applying for one. Only borrow what you need to, and try to repay more than the minimum interest payments.

Alternatively, you could ask for a lower limit when applying, so you’re not tempted to spend more than you should. Regardless of how you approach a HELOC, ensure that you understand the terms and conditions and are confident you can pay back your loan.

Pros and cons of a home equity line of credit

Pros

Open-ended credit can give you flexibility. Revolving debt can allow you to respond to financial needs or opportunities if they arise. Pay for renovations that will increase your home’s value or consolidate higher-interest debt, for example.
Competitive interest rates. HELOC interest rates are typically lower than credit cards and personal loans.
Make interest-only payments. Minimum payments are based only on interest.
Easily make additional payments. There are no penalties when making prepayments.
Open-ended ability to borrow. This is not a lump-sum loan. You can borrow any amount — up to your limit — at any time.

Cons

You could lose your home. Missing payments could result in your lender taking possession of your home.
Interest-only minimums can mask the true cost of borrowing. Making minimum payments can add financial flexibility if you need it. But prolonging your repayment schedules means you’ll end up paying more in the long run.
Risk of overspending. The max amount you can borrow might be huge, which may encourage you to spend more.
Switching lenders can be difficult. If you have a HELOC, you may need to pay it off in full before switching to a different lender.
Variable rates inject uncertainty. If you borrow a large amount and interest rates go up, you could be saddled with a repayment amount you can’t easily meet.

Home Equity Loan

With a home equity loan, you’re taking out a second mortgage using your home’s equity as collateral. You’ll get the balance of the loan upfront and pay it off over time according to the terms of the contact. You could have a fixed or a variable interest rate.

Frequently asked questions about home equity lines of credit

Do you have to pay back a HELOC?

You absolutely have to pay back a home equity line of credit. HELOCs typically only require interest-only payments, but you still must pay back the original amount you borrowed to close the account. Until you do, your loan will continue to generate interest payments.

What does your credit score need to be to get a HELOC?

Lenders have different standards, but a credit score of 620 is often enough. Better credit scores usually lead to lower interest rates. You will also need to pass a stress test and have your overall debt situation evaluated before a lender determines how large a HELOC to provide you.

About the Authors

Kurt Woock

Kurt Woock started writing for NerdWallet in 2021 and has covered mortgages, cryptocurrency, electric vehicles and small business software. Prior to joining NerdWallet, Kurt worked for the Colorado Public Employees'…

Clay Jarvis

Clay Jarvis is NerdWallet’s mortgage and real estate expert in Canada. Thus far, his entire professional writing career has revolved around real estate. Prior to joining NerdWallet, he was the…

HELOC: What It Is and How It Works

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