Getting a home equity line of credit (HELOC) is a lot like getting a mortgage, home equity loan, or cash-out refinance loan. But there are significant differences among these loans. What sets apart a HELOC the most is that—much like a credit card—you can borrow as little or as much money as you want as long as you don’t go over your credit limit.
But unlike a credit card, your home serves as collateral for a HELOC. If you fall too far behind on HELOC payments, you risk losing your home to foreclosure.
How to Get a Home Equity Line of Credit
The basic steps you’ll take to get a HELOC include:
- Review your financial situation, such as your income and credit score, to see whether your finances are in good enough shape to get a loan.
- Consider HELOC alternatives, such as a home equity loan, cash-out refinance loan, personal loan, or credit card.
- Figure out whether you’ve got enough home equity to qualify for a HELOC.
- Decide how much money you want to borrow and what you’ll use it for.
- Shop around for a lender, comparing factors such as interest rates, closing costs, and fees.
- Assemble the required documents and information for your HELOC application.
When Is a Home Equity Line of Credit a Good Choice?
A HELOC may be a good choice if you need a big chunk of money for things like a home renovation project, consolidation of higher-interest debt, a down payment for an investment property, or a major purchase like a bucket-list vacation.
This line of credit works much like a credit card does. When you obtain a HELOC, you’re approved for a certain credit limit. You can spend that money during what’s known as the draw period, which is normally up to 10 years. To use the line of credit, you must use a special credit card or special checks, for example.
During the draw period, you make interest-only payments on the amount you’ve borrowed, and not principal-and-interest payments. You pay back only what you’ve borrowed and not the full amount that’s available to borrow. Once the draw period ends, you enter the repayment period, when you make principal-and-interest payments. The repayment period may last up to 20 years.
| HELOC vs. Cash-Out Refinance | ||
|---|---|---|
| HELOC | Cash-Out Refinance | |
| Ease of qualification | Usually more difficult than a cash-out refi | Usually less difficult than a HELOC |
| Relationship to original mortgage | Second loan separate from original mortgage | New loan replacing original mortgage |
| Typical credit score needed | At least 680 (although the minimum may be as low as 620 or as high as 720) | At least 620 |
| Typical debt-to-income ratio (DTI) required | Less than 43% | Less than 50% |
| Typical home equity required | At least 15% to 20% | At least 20% |
| Collateral required | Home | Home |
| Closing costs | Usually none or a small amount | Usually similar to regular mortgage (2% to 5% of loan amount) |
| Loan payout | Periodic withdrawals based on credit limit | Lump-sum payment |
| Interest rate | Usually variable | Usually fixed |
| Payoff period | Often up to 20 years | Perhaps 10, 15, or 30 years |
| Monthly payment amounts | Variable | Fixed |
So, when might be the best time to take out a HELOC?
- When interest rates are low (although the interest rate for a HELOC normally is variable, not fixed)
- When you want to avoid borrowing money at a higher interest rate, such as with a credit card or personal loan; HELOCs often charge lower interest rates than some other lending products
- When you’ve built up an adequate amount of home equity
- When you plan to keep your home for a while, since most HELOCs must be repaid when you sell your home
- When you’re confident about your financial situation, especially your income; this is especially important because your home serves as collateral for a HELOC
What You Need to Get a HELOC
To get a HELOC, you’ll need to meet a lender’s financial, documentary, and property requirements.
Financial Requirements to Get a HELOC
Among the financial requirements to get a HELOC are:
- Income: A lender will look for a consistent track record of income and employment.
- Credit score: To qualify for a HELOC, your credit score usually must be at least 680. However, some lenders might accept a score as low as 620.
- Solid payment history: In reviewing your finances, a lender will check your history of making payments on credit cards and other debts.
- Debt-to-income ratio: Debt-to-income ratio (DTI) represents your monthly debt payments divided by your gross monthly income. Most HELOC lenders require a DTI of 43% or less.
Document Requirements to Get a HELOC
The document requirements to get a HELOC generally include:
- Government-issued photo ID
- Pay stubs from employer or other proof of income
- Past two years of tax returns
- Recent mortgage statements
- Bank statements and other proof of assets
- Credit report
- Proof of homeowners insurance
- Home appraisal estimate
Property Requirements to Get a HELOC
Some of the property requirements to get a HELOC are:
- Home equity: Generally, a lender will approve a HELOC for a homeowner who has at least 15% equity in their home.
- Loan-to-value ratio: For most HELOCs, your loan-to-value ratio (LTV) must be 85% or less. In other words, you usually need home equity of at least 15% to qualify for a HELOC. Your LTV is the current loan balance divided by the current appraised value of your home. Note that this ratio includes both loans: your first mortgage and your HELOC.
- Home appraisal. A lender usually requests an appraisal to accurately determine the value of your home.
A HELOC can be risky. For one thing, taking out a HELOC means you’ll have two loans tied to your home—the HELOC and your mortgage. This means that, at least for a while, you’ll simultaneously be making HELOC payments and mortgage payments. Furthermore, because your home serves as collateral for a HELOC, you could lose it to foreclosure if you fail to keep up with the loan payments.
Choosing a HELOC Lender
When you’re ready to take out a HELOC, it pays to compare several lenders and not go with the first lender you come across. Among the factors you should consider are:
- Do you want to get a HELOC from a bank, a credit union, or an online lender? Some lenders don’t offer HELOCs.
- Would you prefer to do business with your current lender?
- What are a lender’s requirements for obtaining a HELOC, such as the minimum credit score and minimum home equity needed?
- How do lenders’ interest rates stack up against one another?
- What fees will you be charged?
- How much will the closing costs be?
- How simple or complicated is the application process? What types of documents will the lender need?
- What do online reviewers say about the lenders you’re looking at? Does the lender enjoy a good reputation? What is its customer service like?
What’s Negotiable
When you’re working with a HELOC lender, remember that you may be able to negotiate some of the details, such as the:
- Interest rate
- Upfront costs
- Closing costs
- Annual fees
Qualifying for a HELOC means meeting various requirements. For example, you typically need a credit score of at least 680, but a lender’s minimum score might go as low as 620 or as high as 720. Also, you generally need home equity of least 15% to 20%.
Best Mortgage Lenders
In November 2023, Bank of America agreed to pay a $12 million fine to the Consumer Financial Protection Bureau for not asking mortgage applicants their race, ethnicity, and sex, and then saying the applicants didn’t provide that information. The government collects that info from lenders to identify potential patterns of discrimination in mortgage lending. The money from the fine paid will go to a victim compensation fund.
Alternatives to a Home Equity Line of Credit
A HELOC may not be right for you. Fortunately, alternatives are available. Here are four of them.
Home Equity Loan
A home equity loan, also known as a second mortgage, enables a homeowner to tap into their equity to borrow money. Both a regular mortgage and a home equity loan use your home as collateral.
This type of loan gives you a lump sum of money based on a share of your home equity. So, if your home is valued at $350,000 and you owe $250,000, your equity is $100,000. A lender often limits the amount you can borrow to, say, 85%. At that percentage, a lender would let you borrow up to $85,000.
Cash-Out Refinance
With a cash-out refi loan, you get a new mortgage to replace your existing mortgage. The amount of the new mortgage is bigger than your current mortgage balance. You then receive a lump sum of cash that represents a portion of the difference between how much you’re borrowing and how much you owe.
Let’s say your home is valued at $400,000 and your mortgage balance is $150,000. That leaves you with $250,000 in equity. Your lender decides you can borrow $50,000 of that equity, meaning that amount will be tacked onto your new loan balance.
Personal Loan
When you take out a personal loan, you receive a lump sum of money after your application is approved. Generally, you must pay back the loan with fixed monthly payments over a fixed period of time, usually 12 to 60 months. A personal loan may be an attractive option if, for example, you’re making a big purchase, consolidating debt, or covering unexpected medical bills.
You typically can borrow anywhere from $1,000 to $50,000 with a personal loan.
Credit Card
A credit card, especially one with a 0% APR promotional offer, may be a good option if you’ve got a short-term need for cash. A card with a 0% promo offer charges no interest on certain transactions over a set period of time, such as 12 months. The 0% APR may apply to purchases, balance transfers or both.
Once the promo period ends, the regular APR kicks in. So, if a balance remains on the card when the promo period expires, the regular APR will be charged on that balance.
How Does a HELOC Work?
Similar to a credit card, a HELOC is a revolving line of credit based on the amount of equity you have in your home. Up to a lender-approved credit limit, you can borrow any amount of money you like.
During the borrowing period, known as the draw period, you usually pay interest only on the amount you borrow. But if you make payments on the balance during that period, the amount of available credit is replenished. After the draw period expires, you make payments on the interest as well as the principal.
How Does a HELOC Affect Your Credit Score?
A HELOC can either benefit or damage your credit score. If you make timely payments on a HELOC, your credit score may go up. But if you make late payments or miss some altogether, your credit score could go down. Payment history makes up 35% of the widely used FICO credit score.
How Is a HELOC Paid Back?
Once the draw period for a HELOC ends—the period when you can borrow against your line of credit—the repayment period begins. During the draw period, you usually make monthly payments only toward the interest. When the payoff period takes effect, the monthly payments cover both the interest and the principal. The draw period usually lasts 10 years, and the payoff period normally lasts 20 years.
Is HELOC Interest Tax Deductible?
Whether you can claim a tax deduction for HELOC interest is a murky matter. For the 2018 through 2025 tax years, a HELOC interest deduction is not allowed. Meanwhile, interest paid on a HELOC before the 2018 tax year and after the 2025 tax year is deductible only when you use HELOC funds to buy, build, or “substantially improve” the home that serves as collateral for the loan.
