How Does a Home Equity Line of Credit Work?

A home equity line of credit, or HELOC, is a loan that allows you to borrow against your home's equity. It's an open-ended line of credit, meaning you can access money when you need it instead of borrowing the whole amount at once. Your home acts as collateral.

Why HELOCs are Popular in 2024

Maybe you hoped to buy a new house in 2024 but current mortgage interest rates are still too high, or you're worried about a difficult real estate market. A HELOC could help make your current home more comfortable so you can stay put for a while longer.

According to the most recent 2023 CFPB data, HELOCs are more common than other loan-equity options, including cash-out refinancing. "This is most likely due to some consumers using HELOCs instead of cash-out refinance loans in a high-interest rate environment," the report states. 

HELOCs also tend to be a popular option — not just in 2024 — because of their flexibility. Borrowers can use what they need instead of borrowing lump sum.

Important: Make sure you can pay back your loan, otherwise, you risk losing your home. Using a HELOC for credit card debt consolidation might reduce the interest you pay, but it's important to identify the underlying cause of your debt first so you don't end up charging to your credit cards again and increasing your debt even more.

How Does a HELOC Work? 

Here's how HELOCs work from the draw period to the payoff. 

Draw Period and Interest Payments

A HELOC is an open-ended loan that works much like a credit card. You'll first have a draw period during which you can access funds (called advancing) up to your credit limit. The financial institution may establish rules regarding your advances from the HELOC. For example, you may be required to advance a specific minimum, such as $100. 

You can repay the borrowed amount on the revolving credit account, then, borrow it again, similar to a credit card.

At BECU, for example, you could access funds for 10 years up to your credit limit. The line of credit is listed with other accounts in BECU Online Banking. You can transfer funds from the HELOC account to your checking account on the same day. 

During the draw period, you're usually only required to make a monthly payment of the accrued interest (minimum payments may apply). But if you make interest-only payments, you could have higher overall costs and higher monthly payments in the long term. To reduce costs and adjust to your eventual payment amount, try to pay some of the principal and interest. This will also help you pay your loan off earlier.

Repayment Period

Once your draw period ends, you will no longer have access to funds from your HELOC. If your HELOC account has an outstanding balance, the minimum payment will include both principal and interest payments. 

At BECU, the repayment period is 15 years, but this repayment period can vary by bank or credit union. At some point, you must pay off the remaining balance. 

HELOC Example

You owe $300,000 on your traditional mortgage, but your home value is $700,000. You applied for and were approved for a $50,000 HELOC. 

For the next 10 years, you can withdraw some or all of the $50,000 HELOC at any time, pay off what you borrowed, and then borrow again. Every month, you'll pay your primary mortgage and a separate payment on the HELOC amount. However, you're only required to pay the interest on the HELOC. 

After 10 years, your HELOC goes into a repayment period. You can no longer withdraw money from the line of credit; you just repay what you owe. 

Suppose you borrowed $25,000 of your $50,000 HELOC and already repaid $5,000. During the 15-year repayment period, you will repay the remaining $20,000 balance in monthly installments.

Variable Interest Rate vs. Fixed Interest Rate 

Most HELOCs have a variable annual percentage rate, or APR, which means the interest rate can go up or down on any advance you take. For example, the APR could be based on the Wall Street Journal Prime Rate in effect on the last day of the previous month, plus a margin (a percent) your bank sets that is added to the index.

If a loan has an adjustable interest rate, the amount due can change alongside interest fluctuations. Even if the borrowed amount stays the same, the payment due will increase if the index increases. If the index decreases, the payment amount could decrease. In a rising interest rate environment, make sure you can keep up with payments. 

Each HELOC will have an interest rate cap (maximum) and floor (minimum) APR charged. For example, at BECU, this APR will not exceed 18% or go below 3.25%.

Your HELOC rate and loan amount depend on your credit history, occupancy type (whether it's your primary home, second home or a rental property, for example) and other factors. A range of rates will typically be available, and the rate can fluctuate monthly over the loan's life.

Fixed Interest Option 

Some HELOC lenders offer a fixed-rate advance option. With these, you borrow a lump sum at a fixed interest rate and a fixed term. The lump sum becomes part of your overall balance on your credit line. As you pay down the principal on your fixed rate advance, that amount becomes available to use on your credit line. 

The minimum amount for the lump sum may differ. At BECU, the minimum is $5,000. 

Depending on the current index, these fixed rates may be higher than the variable rate but provide payment consistency. The fixed rate payment typically includes principal and interest.

How Much Can I Borrow with a HELOC?

The amount you can borrow depends on your home's equity. Different banks and credit unions set maximum borrowing limits. At BECU, for example, the limit is up to $500,000. However, your limit will depend on other variables, including your combined loan-to-value ratio, occupancy type and income.

Someone who has paid down more of their original mortgage, has a high credit score, strong credit history and has more available equity may be able to borrow more money with a HELOC.

How Much Does a HELOC Cost?

Be sure to compare fees between various HELOC lenders regarding potential costs. Costs can vary depending on your institution, your state of residence, and other factors. 

Some financial institutions charge fees and other closing costs when you get a HELOC. Here are a few examples: 

• Application fees
• Origination fees 
• Appraisal costs
• Title insurance fees
• Document mailing fees
• Escrow fees
• Attorney fees

While your HELOC account is open, the bank or credit union may also charge ongoing or intermittent fees, including:

• Account maintenance fees.
• Inactivity fee if you're not using your line of credit.
• Minimum balance fee if you're required to keep a certain loan balance.
• Pre-payment penalty fees.

Check your financial institution's account disclosures (PDF) for details about what fees are charged. BECU doesn't charge origination fees. When you close and pay off a BECU HELOC, you will be charged a reconveyance fee to remove the lien from your property.

How To Qualify for a HELOC

As of late 2023, many financial institutions have tightened lending requirements for HELOCs.

New requirements might include lower credit limits, higher minimum required credit scores and fewer loans given to customers who don't meet the required credit scores.

Check your credit score and compare requirements across different HELOC lenders. Remember that the HELOC will affect your credit score, so ensure you can make timely payments.

HELOCs vs. Alternatives

A HELOC allows you to borrow money using your home as collateral, and you can withdraw funds over time. Compare options from multiple lenders.

• Home equity loan: Borrow against your home's value, similar to a HELOC, but typically at a fixed interest rate. The loan is also disbursed (given to you) in a lump sum, without a HELOC's draw and repayment periods or credit limit option. (BECU doesn't offer this type of loan.)
• Home improvement loan: Typically, this loan is not secured by property and used only for home improvement. It also may have different borrowing limits and terms. For example, at BECU, the maximum loan amount is $35,000 and 84 months as of Aug. 1, 2024.
• Personal loans: A personal loan does not require home equity but limits you to a lower amount, which is provided all at once.
• Credit cards: You can find credit cards that offer airline miles or cash-back refunds, but these tend to have relatively high and variable interest rates that apply to any balance you carry from month to month. Like a HELOC, you can spend and repay every month.

HELOC FAQs 

Can I Get a HELOC for Any Type of Property? 

Your financial institution may limit which types of property are eligible for a HELOC. For example, BECU offers a HELOC for single- and multi-family homes, town homes, condos and manufactured homes. 

Can I Get a HELOC for Any Type of Occupancy?

Your financial institution may limit which types of occupancy are eligible for a HELOC. For example, BECU offers a HELOC for a primary residence, second home, vacation home, investment property or rental property.

Is HELOC Interest Tax Deductible?

HELOC interest may be tax-deductible, but the eligibility depends on factors such as how you used the funds and the tax year. Consult with your financial advisor, tax advisor or attorney for advice, and read more at the Internal Revenue Service (IRS) website.

Which is Better? A HELOC or Home Equity Loan

If you make the bulk of your large purchases immediately or have one project in mind, a home equity loan could be a better fit. But you may prefer a HELOC if you'll use the money for multiple projects over an extended period. (BECU doesn't offer a separate home equity loan, however, the fixed-rate advance option functions much like a home equity loan within a HELOC.) 

With a HELOC, you can avoid accruing interest on money before you need it. You can borrow and repay as you go for the length of your draw period. 

How Often Can the Interest Rate Change on a HELOC?

If you have a variable-rate HELOC, your bank or credit union can increase your HELOC interest rate at any time. A HELOC's interest rate is tied to an index or formula that changes periodically. However, your bank or credit union must tell you your new rate on your periodic statement sent before your next payment's due date. At BECU, your variable rate may change monthly depending on changes with the index.

The Big Picture

Whether you need to add a new room to your house, expand your kitchen or complete another project, a HELOC can provide funds to achieve your goals. Just be sure you can afford repayments, even if interest rates rise. 

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