A home equity line of credit (HELOC) gives you flexible access to your home’s equity, but understanding how it actually works, from the moment you apply through the final payment, helps you use it strategically and avoid surprises.
This guide walks you through each phase of a HELOC: how to qualify, how to access your funds, and what to expect as you move from borrowing to repayment.
The Two Main Phases of a HELOC
Unlike a traditional loan where you receive a lump sum and start repaying immediately, a HELOC has two distinct periods:
- Draw Period: Typically 10 years. During this time, you can borrow money up to your credit limit, pay it back, and borrow again. Many HELOCs require only interest payments during this phase, though you can pay down principal if you choose.
- Repayment Period: Typically 10 to 20 years. Once the draw period ends, you can no longer borrow. You’ll repay both the principal and interest, usually in fixed monthly payments. This is when your payment typically increases.
How to Qualify for a HELOC
Lenders evaluate several factors when deciding whether to approve your HELOC application:
- Home Equity: Most lenders require you to have at least 15-20% equity remaining in your home after the HELOC is established. This means you can typically borrow up to 80-90% of your home’s value, minus what you still owe on your mortgage.
- Credit Score: Generally, you’ll need a credit score of at least 620, though higher scores (700+) get better rates and terms.
- Income and Debt-to-Income Ratios (DTI): Lenders want to see stable income and that your total monthly debt payments (including the new HELOC) don’t exceed a certain percentage of your gross income, usually around 43%.
- Home Valuation: Most lenders require a current appraisal to determine your home’s market value and verify your available equity. Some lenders use an automated valuation method instead of an in-person appraisal.
The Application Process
Applying for a HELOC generally follows these steps:
- Submit an Application: Provide information about your income, employment, debts, and property.
- Documentation: This varies widely across lenders. Some may require you to provide pay stubs, tax returns, mortgage statements, and proof of homeowners insurance. Other lenders rely on third-party data sources and allow you to verify income online by connecting your bank or other financial accounts.
- Valuation: The lender orders an appraisal to confirm your home’s current value or pulls the value through an automated valuation method (“AVM”).
- Underwriting: The lender reviews your financial profile and determines your credit limit and interest rate.
- Closing: If approved, you’ll sign loan documents. Unlike a mortgage refinance, HELOC closings are often simpler and may even be done electronically.
- Timeline: The entire process typically takes 2-6 weeks, depending on the lender and how quickly you provide documentation. Some lenders can complete the process in a matter of days.
How You Access Your HELOC Funds
Once your HELOC is active, you have several ways to access your money, depending on your lender:
- Checks: Write checks directly from your HELOC account.
- Credit Card: Some lenders provide a card linked to your line of credit for purchases or ATM withdrawals.
- Online Transfer: Transfer funds from your HELOC to your checking account electronically.
- Balance Transfer: Transfer funds from your HELOC to existing credit card or personal loan accounts to pay down higher-rate debt.
- In-Person at a Branch: Visit your lender to request a withdrawal.
You can take as much or as little as you need, up to your credit limit, at any time during the draw period. You only pay interest on the amount you actually borrow. Note, however, that some lenders require large or 100% upfront draws.
Understanding HELOC Interest Rates
Most HELOCs have variable interest rates tied to a benchmark like the Prime Rate. This means your rate, and your payment, can change over time as market rates fluctuate.
Some lenders offer:
- Fixed-Rate Options: Lock in a fixed rate on all or part of your balance.
- Rate Caps: Limits on how high your interest rate can go, providing some protection against dramatic rate increases.
- Introductory Rates: Promotional rates for the first few months, after which the rate adjusts to the standard variable rate.
Because rates are variable, your monthly payment can increase if interest rates rise, and likewise, they can decrease if interest rates decline. Budget accordingly and understand your lender’s rate terms.
Making Payments During the Draw Period
During the draw period, yoiu have flexibility in how you repay:
- Interest-Only Payments: Many HELOCs allow you to pay only the interest each month, keeping payments low. However, this means your principal balance doesn’t decrease.
- Principal and Interest Payments: You can choose to pay down the principal along with interest, reducing your overall debt and future repayment burden.
- Pay Off and Re-Borrow: Because it’s revolving credit, you can pay down your balance and then borrow again if needed, as long as you’re still in the draw period.
What Happens When the Draw Period ends
Once your draw period ends, your HELOC enters the repayment period. Here’s what changes:
- No More Borrowing: Your line of credit closes. You can no longer access additional funds.
- Payment Increases: You’ll now repay both principal and interest, typically in fixed monthly payments over 10-20 years. This often results in a significantly higher monthly payment than during the draw period.
Planning ahead for this transition is crucial. If you’ve been making interest-only payments, expect your payment to jump when the repayment period begins.
Fees and Costs to Watch For
While HELOCs are often less expensive to set up than refinancing, they can come with various fees:
- Appraisal or Valuation Fee: Typically $300-$500, though some lenders waive these fees.
- Application or Origination Fee: Commonly $500-$1,000, though some lenders waive this
- Annual Fee: Some HELOCs charge a yearly maintenance fee
- Inactivity Fee: A fee if you don’t use your line of credit within a certain timeframe
- Early Closure Fee: A penalty if you close your HELOC within the first few years
- Transaction Fees: Fees for each withdrawal or transfer
Ask your lender for a full breakdown of fees before committing.
Can You Pay Off a HELOC Early?
Yes, in most cases you can pay off your HELOC early without penalty—but check your specific loan terms. Some lenders charge an early closure fee if you pay off and close the line within a certain period (often 2-3 years).
Paying down your HELOC early can save you significant interest, especially if you have a variable rate that’s rising.
What Happens If You Can’t Make Payments?
Because your home secures a HELOC, failing to make payments puts your property at risk.
Consequences of default can include:
- Late Fees and Penalties: Immediate financial penalties for missed payments
- Damage to Your Credit Score: Late payments are reported to credit bureaus
- Foreclosure: In severe cases of non-payment, the lender can foreclose on your home
If you’re struggling to make payments, contact your lender immediately. They may offer options like payment plans, temporary forbearance, or loan modification.
Tips for Using Your HELOC Wisely
- Borrow with Purpose: Use your HELOC for investments that add value—home improvements, debt consolidation at lower rates, or true emergencies—not discretionary spending.
- Pay Down Principal When Possible: Even during the draw period, paying more than the interest-only minimum reduces your debt and future payment shock.
- Monitor Interest Rates: Keep an eye on rate changes and consider locking in a fixed rate if available and rates are rising.
- Plan for the Repayment Period: Don’t wait until your draw period ends to figure out how you’ll handle higher payments. Budget now.
- Maintain an Emergency Fund: Don’t rely solely on your HELOC as your only financial safety net.
The Bottom Line
A HELOC offers powerful financial flexibility, but it works best when you understand the mechanics: how to qualify, how to access funds, how interest accrues, and what happens when the draw period ends.
By knowing what to expect at each stage, and planning for the transition from draw to repayment, you can use your HELOC strategically, avoid payment surprises, and make the most of your home’s equity.
