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What is a HELOC? Tap into your home's equity

Everything you wanted to know about a HELOC, from how it’s calculated, to the rates, repayment, benefits, challenges and determining whether it’s right for you.

Updated

12 min. read

If you own a home and are thinking about a major purchase – like a home renovation, new appliances or even consolidating your debt — a home equity line of credit (HELOC) can help you access the funds you’ll need.

But what exactly is a home equity line of credit? Let’s start with the basics.

What is a Home Equity Line of Credit (HELOC)?

A home equity line of credit, commonly known as a HELOC, is a revolving credit line that allows you, as a homeowner, to borrow up to a set amount of money based on the equity you’ve built in your home.

The line of credit is secured by your property which is used as collateral so that you can access funds during a fixed period of time. You can choose to borrow the funds all at once as a lump sum or in smaller increments throughout that period.

With a HELOC, you only pay interest on the amount you borrow, and they typically offer lower interest rates than many other types of loans. While rates are often variable, some lenders, like BMO, also offer a fixed-rate option.

Popular ways homeowners can use a HELOC

HELOCs are a flexible way to get the funds you need, no matter your goals. If enough equity has been built and can be accessed, a HELOC can prove extremely valuable. Here are just some of the ways you can use a HELOC:

Renovate your home: Make your home more enjoyable – and valuable - by investing in home improvement projects.
Consolidate your debt: Simplify your debt by consolidating your higher interest debts into one monthly payment.
Make a big purchase: Get the funds you need for tuition expenses, or any other costly items you may need.
Cover extensive medical care: Medical bills can rise unexpectedly. A HELOC allows you to take care of what’s important, without compromise.
Invest in your future: Leverage your HELOC to make investments, including an investment in property, whether a rental property or a second home.
Have an emergency fund: Be prepared for unexpected expenses, like a new roof or sump-pump, with a line of credit that lets you use it when you need it.
General cash management: A HELOC is a nice tool to have in your back pocket to manage your finances when anything unexpected arises.

HELOC eligibility and borrowing limits: How much can I borrow, and do I qualify?

First, remember that the amount of credit you have access to is based on the equity you've built in your home. It's essential that homeowners know how much they can borrow when considering a HELOC and whether it's a good fit for your goals.

How much can you borrow with a HELOC?

A good rule of thumb is that, depending on your lender, you can typically borrow up to 80% or more based on the appraised value of your home, minus the amount you owe on your first mortgage.

Say your home is worth $300,000. Multiply that by 80%, then subtract what you still owe. For this example, we’ll say that’s $100,000. 80% of $300,000 is $240,000, then by subtracting the $100,000 that you still owe would mean that you have $140,000 to potentially borrow.

If you prefer not to do the calculation on your own, a great place to start, is to determine the cost of the project or need. Take note of the amount of equity you have in your home and use a HELOC calculator to see how much you can borrow and whether it will cover the anticipated need.

Requirements to get a HELOC

Financial institutions will assess several factors to determine if you qualify for a HELOC. They’ll collect some of your personal information, including details about your property, and get permission to pull and review your credit report. They’ll also let you know about any additional documentation they might need for your application. Some key aspects they consider include:

Your income and employment history
The equity available in your home
Your credit history and current credit score
Any outstanding debts

These considerations all help lenders better predict if you’re able to repay the loan principal and interest.

How do HELOCs work?

Now that we've covered how to calculate your borrowing limit, let’s turn our attention to understanding the key stages of using a HELOC.

There are two phases of a HELOC: the draw period and the repayment period.

The draw period

The draw period marks the first stage of the HELOC process, allowing you to borrow funds as often as you like, up to your approved limit.

This phase typically lasts 10 years, during which you are only required to make interest payments on what you’ve borrowed. While optional, you also have the flexibility to make additional payments towards the principal.

The repayment period

The next phase kicks in once you’ve reached the end of the draw period. At this point, you can no longer borrow from the HELOC and will need to start repaying the amount that you’ve borrowed in addition to the interest payments that were already being paid.

Depending on your lender, a monthly repayment schedule will begin until the full balance of what was borrowed is repaid, which is usually set at 10 to 20 years.

Since HELOCs traditionally come with a variable interest rate, your payments may go up and down. There is sometimes an opportunity to convert some or all of your balance from a variable rate to a fixed interest rate. Despite its greater predictability, keep in mind the fixed rate is usually higher than the variable one.

“HELOCs are a flexible way to get the funds you need, no matter your goals”

How are HELOC interest rates determined and are there fees?

Because you are securing your line of credit based on the equity you’ve built in your home, the interest rate is often lower than with other types of loans. While variable rates are more typical for HELOCs, there are also fixed rate options available.

Let's explore both and how they’re calculated.

Variable Rate HELOCs

Most HELOC interest rates are variable, meaning it’s common to see your interest payments fluctuate, during both the draw and repayment periods. These variable rates are calculated by something called an index and a margin.

When calculating your uniquely determined HELOC rate, the lender will look at:

The index: This base rate is determined by the market and offers a good foundation upon which to calculate the HELOC rate. The prime rate set by the lender can be assessed from the standing of the market. But lenders can also use a standard index like the U.S. prime rate or the Constant Maturity Treasury (CMT).

The margin: This set amount is combined with the index to calculate your interest rate. Your unique financial resume – e.g., credit score, debt to income ratio and loan amount – will play a part in determining how much will be added to the index.

Before you sign on the dotted line, make sure to read all the borrowing terms, including how your interest rate will adjust and the lifetime cap (how high the interest can go during the length of the HELOC).

Fixed Rate HELOCs

Though variable rates are the norm, a fixed rate HELOC option is sometimes also available. It allows you to lock in a portion of, or your entire balance, at a fixed interest rate, protecting you against market fluctuations. Once the fixed rate balance is paid down, the principal (which has been paid off) is available again for use.

HELOC fees

As for fees, you may need to pay closing costs. Some HELOCs may also require an annual fee, other participation and transaction fees, or early termination fees.

What are the benefits and limitations of a HELOC?

To determine whether a HELOC is right for you, consider your financial situation and what you want to achieve through your financial goals. Examining the pros and cons can prove valuable in making that decision.

Benefits of a HELOC

Lower interest rates: As compared to credit cards or unsecured loans, the interest rate for a HELOC is often lower.

Flexibility: You can access as much or as little funds from the account as you need (up to your limit), whenever you need it.

Interest-only payments: With HELOCs, you have the flexibility to choose interest-only payments, meaning you can delay repaying the principal balance until the repayment period kicks in.

Potential tax savings: Many homeowners turn to a HELOC to complete major home renos. Those investments can pay off in the long-term and you may be able to write off your interest when funds are used for home improvements.

Drawbacks of a HELOC

Risk of foreclosure: Since your home is used as collateral, if you can’t repay the funds, you can lose your property.

Variable rates create uncertainty: With variable rates, payments can increase and decrease over time. This could be considered risky if your budget is unable to accommodate unexpected changes.

May be difficult to qualify: Lenders use the combined loan-to-value (CLTV) ratio to determine your risk to borrow – the ratio of all secured loans on your home to the current value of the property. A CLTV ratio of less than 80% is often needed to qualify for a HELOC.

Fees & costs: Be sure to keep in mind the possible fees and closing costs involved, including one-time payments like application and appraisal fees, as well as recurring costs like annual maintenance fees.

HELOCs vs home equity loans (HELOAN)

HELOCs and home equity loans share some of the same features – e.g., both allow homeowners to borrow money based on their home’s equity and both can be used for larger purchases or debt consolidation.

However, they work a little differently, which could influence your decision on which product might be more suitable for your needs. Let’s have a closer look.

	HELOC	Home Equity Loan
How it works	More flexible, credit can be used as you need it over a set period of time called the draw period, typically 10 years, followed by a repayment period up to 20 years.	You borrow a one-time lump sum which is paid back monthly over a set period of time.
Interest rate	Has a variable interest rate, meaning rates and payments may change over time. Interest rate is tied to the prime rate, plus percentage based on factors like your home’s location and condition, loan amount & your credit history. Some lenders offer the option to lock in all or a portion of your line at a fixed rate.	It's a fixed rate loan, meaning the payment and interest rate are the same each month. Your interest rate is based on factors like your home’s location and condition, loan amount & your credit history.

Which one should I choose?

There are many things to consider before choosing one option over another. Why you’re borrowing is a primary consideration.

If you’re borrowing for small, less expensive needs, a personal loan may work best. If it’s for costly repairs, tapping into the credit you’ve built up in your home can be a smart way to borrow as they have lower rates, longer repayment terms and keep your monthly payments lower.

For a more in-depth comparison, check out our article: Home equity line of credit vs. home equity loan: Which is better?

Tips on using a HELOC responsibly

Consider the financial risk and reward of using a HELOC, and ensure you are borrowing with intent to meet important financial goals or needs. Avoid over-borrowing for purchases beyond your means, and always be mindful of your current financial situation.

Remember, using a HELOC unwisely can lead to debt or even the loss of your home.

Let’s recap

So what is a home equity line of credit? It can be an easy way of tapping into the hard-earned equity you’ve built in your home. HELOCs often have lower interest rates than other types of loans and are usually variable. Most lenders will allow you to borrow up to 80% or more of the value of your home (subtracted by the amount owing on the mortgage).

If you’re looking to purchase a minor item, other lending tools may be better for you. Be sure to weigh your options to find what's right for you and your financial goals.

Frequently Asked Questions about HELOCs

It’s easy to tap into the funds in your HELOC. You can transfer money to a checking account through online or mobile banking, by phone, at a branch or using a checkbook that your lender will give you to access your funds.
During the draw period, you have required monthly payments which typically cover the interest only. In the repayment period, monthly payments include both principal and interest and follow a set term, often as long as 20 years.
Yes you can pay off a HELOC early, but closing your line may result in prepayment fees. To avoid these fees, simply keep your line open with a zero balance.
Interest from a HELOC can be tax deductible if you’ve used the loan for home improvements. The IRS uses various criteria which will determine that outcome. We recommend that you speak with your tax advisor for details.
You can refinance a HELOC assuming you have enough equity in your home and meet other qualifications as determined by your lender.
Of course! In most cases you have a three-day right to cancel after you close on a home equity loan or line of credit. You can generally cancel for any reason, without penalty by sending a request in writing through the mail or by fax. You can ask your lender about situations where the three-day right to cancel doesn’t apply.