What is a Home Equity Line of Credit (HELOC)?
A Home Equity Line of Credit (HELOC) is a revolving credit line secured by the equity in your home. Unlike a traditional fixed-rate loan that distributes a single upfront lump sum, a HELOC functions much like a high-limit credit card backed by residential real estate. Borrowers are approved for a specific borrowing limit and can withdraw, repay, and re-borrow money as needed.
A HELOC is structured into two consecutive time phases:
1. The Draw Period (Typically 5–10 Years)
During this initial phase, you have continuous access to your approved credit line. Most lenders require only interest payments on the drawn balance, providing budget flexibility while you access funds.
2. The Repayment Period (Typically 10–20 Years)
Once the draw period concludes, the credit line closes to further withdrawals. Monthly payments shift to fully amortizing installments that pay off both principal and remaining interest.
HELOC vs. Home Equity Loan: Key Differences
| Feature | HELOC (Line of Credit) | Home Equity Loan |
|---|---|---|
| Fund Disbursement | Revolving credit drawn on demand | One-time lump sum upfront |
| Interest Rate Structure | Variable (tied to Prime rate) | Fixed for the loan duration |
| Monthly Payment | Interest-only during draw; P&I in repayment | Predictable, equal monthly installments |
| Best For | Staged remodeling, emergency reserves, ongoing costs | Large immediate expenditures (debt consolidation, major roof replacement) |
How Much Can You Borrow on a HELOC?
Lenders establish your maximum credit limit based on your Loan-to-Value (LTV) ratio. In real estate lending, most institutions allow a maximum combined loan-to-value (CLTV) between 80% and 85%.
Example Calculation: If your home is appraised at $600,000, your current first mortgage balance is $250,000, and your bank permits an 80% maximum LTV:
Max Total Debt = $600,000 × 0.80 = $480,000
Available HELOC Credit Limit = $480,000 − $250,000 = $230,000
Frequently Asked Questions (FAQ)
What causes "payment shock" when entering the repayment period?
When the draw period ends, you are no longer permitted to pay interest only. Your new monthly obligation immediately includes principal amortization over the remaining loan term. On a $100,000 line, monthly payments can often more than double overnight.
What closing costs and annual fees are associated with HELOCs?
HELOC closing costs typically range between 2% and 5% of the credit limit and cover appraisal fees, title searches, document preparation, and notary services. Additionally, many institutions charge an annual maintenance fee ($50–$100/year) during the draw period.
Is HELOC interest tax-deductible?
According to the IRS, HELOC interest is generally tax-deductible only if the borrowed capital is used to "buy, build, or substantially improve" the home securing the loan. If funds are used for personal consumption, vehicles, or student loans, the interest is not deductible.