How a HELOC works
A HELOC allows you to borrow as needed up to a certain credit limit. As you pay it down, you’re able to continue borrowing more. This flexibility can be convenient if you’re financing a series of expenses.
The lender uses your home’s value to set the HELOC limit, and they’ll let you borrow a percentage of what you own. You may borrow during a draw period that lasts for several years (usually 10) and pay interest only on the balance. After the draw period ends, you can’t borrow any more and you pay the principal plus interest.
To obtain the best HELOC rates, make sure you shop around with at least three lenders. This will help you find the combination of features and interest rates that make the best HELOC for your needs. The best rates are also typically reserved for borrowers with excellent credit scores and little existing debt.
Pros and cons of HELOCs
Pros
Flexibility. You can borrow what you need as you need it, up to your credit limit.
Low initial payments. During the draw period, the minimum monthly payment usually covers just the interest on the balance, and you aren’t required to pay the principal.
Cons
Payments can be unpredictable. Most HELOCs have a variable interest rate, which means it can go up or down over time. When the interest rate rises, the minimum monthly payment will increase, too.
Risk of foreclosure. If you can’t keep up with your monthly payments — especially if you made the minimum interest payment during the draw period and aren’t prepared to pay the principal — you could lose your home.
Alternatives to HELOCs
A HELOC is not your only option for tapping your home's equity.
Home equity loans: You receive the cash as a lump sum and pay it back at a fixed rate. While this has less flexibility than a HELOC, payments are predictable. This can be a solid choice if you know exactly how much you need to borrow.
» MORE: Best home equity loan lenders
Cash-out refinances: Replaces your original mortgage with a larger one, and you receive the difference between the new loan amount and your current mortgage balance in cash. This is likely to be your best option if rates have fallen since you closed on your mortgage.
Shared appreciation agreements: For those who cannot qualify for a HELOC but need cash flow. You sell off a stake in your future equity earnings to a company in exchange for an advance on some of your current equity. This type of agreement is typically for homeowners with a lot of equity but not enough savings. Most consumers are better served by a HELOC if they qualify.
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Frequently asked questions
- What credit score do you need for a HELOC?
Lender requirements vary, but typically you'll need a credit score of 620 or higher. Taking out a HELOC will probably reduce your credit score temporarily when it appears on your credit report.
- Is a HELOC tax-deductible?
The interest you pay each year on a HELOC is tax-deductible up to a limit as long as the borrowed money is used to buy, build or substantially improve your home, according to the IRS. This requirement expires after the 2025 tax year.
