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What is a HELOC?
A home equity line of credit, or HELOC, is a second mortgage that allows you to borrow against some of your home equity. Home equity is how much of your home you really own, calculated by subtracting the amount you owe on your mortgage from your home's current value. If you have at least 15% equity in your home, you may be able to get a home equity line of credit.
What's the difference between a HELOC and a home equity loan?
HELOCs and home equity loans are junior liens, aka second mortgages. These loans are secured by your home but are separate from your primary mortgage.
A HELOC gives you a line of credit that lets you make withdrawals as needed. You don't necessarily need to use the entire amount that you can borrow, though you may be required to make minimum withdrawals. You pay interest only on what you've borrowed, not on the whole line of credit. HELOCs usually have variable interest rates.
A home equity loan lets you borrow a one-time lump sum. You pay interest on the entire loan, but most home equity loans have a fixed rate, so the payments are more predictable. However, you don't have the flexibility of borrowing only what you need — even if you end up needing less cash, you've already got the loan.
What's the difference between a HELOC and a cash-out refinance?
A cash-out refinance gives you a new mortgage for more than the amount left on your home loan. The difference between what you owe and the new loan amount is the "cash out."
Because you're replacing your primary mortgage with a new one, a cash-out refinance comes with a new interest rate. When interest rates are falling, this can be a win-win because you get the money you need and refinance to a lower rate. But when interest rates are rising, you can be saddled with a higher interest rate on a larger loan.
Because a HELOC is a second mortgage, getting one does not change your current home loan interest rate. HELOCs also tend to have lower closing costs than cash-out refinances. With both types of loans, closing costs are generally between 2% and 5% of the amount borrowed. But because you're usually borrowing much more with a cash-out refinance, those are percentages of a substantially larger sum.
Is a HELOC a good idea?
Our HELOC calculator can tell you whether you might be eligible to borrow against your home equity. But no calculator can tell you whether tapping into that money is a good idea.
Getting a HELOC can make sense for projects that may increase your home’s value, such as major repairs or remodeling. Bolstering your property's worth builds the value you're borrowing against, making renovations a relatively safe use of the funds. But drawing from home equity is riskier for other uses, such as covering vacation expenses, paying off credit card debt or buying a car. No matter the reason, your home is the collateral for the HELOC, so failure to make payments on it can lead to foreclosure.
HELOCs are set up in two phases. The draw period, which can last as long as 10 years, is when you borrow money. That's followed by the repayment period, which can last up to 20 years. In the repayment period, you can't withdraw additional funds.
During the draw period, you’re usually required to make only interest payments. As a result, your monthly bill will be quite small — and even smaller if you have a low introductory interest rate. But once the repayment period kicks in, you'll have to make payments against the principal and interest.
If you've been spending and paying back the minimum, the repayment period's much larger monthly bills can be a rude awakening. Chipping away at the principal during the draw period is helpful if you can manage it. Depending on the lending market, you might also be able to refinance your HELOC to a fixed-rate loan when the repayment period begins so your payments are more predictable — and some lenders offer HELOCs with fixed-rate options.
When you're comparing HELOC lenders, make sure to read the fine print. Ask if there’s a prepayment penalty, which can make it pricier to pay down principal during the draw period. Make sure there’s no minimum required withdrawal so you aren't forced to take out money you don't need. And make sure you understand the variable rate, including how high it could potentially go.
How are HELOC payments calculated?
Calculating the monthly payment on a HELOC is tricky because the amount you owe each month can vary depending on several factors.
Your interest rate. Home equity lines of credit generally have adjustable rates, which increase or decrease based on prevailing interest rates. The rate you're offered also depends on factors like your credit score, your equity and how much you're borrowing. Some HELOCs have low introductory interest rates, so you may start out with especially low payments — it's important to make sure your budget can handle larger payments down the road.
Age of the loan. If you're within your loan's draw period, you'll be required to make payments only against the interest. This means your payments can be much lower than during the repayment period, when — as the name implies — you repay the principal and interest. Unless you make payments toward your principal during the draw period, your monthly payment will likely be substantially higher during the repayment period.
Rate caps. The adjustable rates on a home equity line of credit come with two key parameters. One is the lifetime cap, which is the highest interest rate you could possibly pay. The other is the periodic cap, which is how often the interest rate can change. Each of these can affect the amount of your monthly payments.
» MORE: See today's HELOC rates
Find the best HELOC lender for you
It pays to shop around when searching for the best deal on a HELOC. Check with your primary bank or mortgage lender, which might offer an existing-customer discount. Take that quote and compare it with quotes from at least two other lenders.
Pay attention to all the terms being offered by the lender. You may have a low-interest introductory period (sometimes referred to as a "teaser rate"), but you'll want to look at the lifetime cap to estimate how high your monthly payment could get. You may be able to negotiate with the lender so part of the HELOC has a fixed rate or for the ability to partially pay down the principal during the draw period.