How to take out equity line of credit

A home equity line of credit (HELOC) is a revolving form of credit secured by your property. You can borrow as little or as much as you need, up to your approved credit line and you pay interest only on the amount that you borrow. You can take advantage of flexible repayment terms, and you can use the credit again as you pay down the balance.

Here are some of the most commonly asked questions about HELOCs.

What can a home equity line of credit be used for?

A HELOC is well suited for large, recurring expenses, such as your child’s college tuition or a remodeling project that may last several years. HELOCs also are ideal for unexpected home emergencies or medical expenses.

How do you find out how much equity you have in your home?

Your equity is the share of your home that you own versus what you owe the lender on your mortgage. For example, if your home is worth $300,000 and you have a mortgage balance of $150,000, your equity in the home is $150,000.

How long do you have to repay a HELOC?

HELOC funds are borrowed during a “draw period,” typically 10 years. Once the 10-year draw period ends, any outstanding balance will be converted into a principal-plus-interest loan for a 20-year repayment period.

Can I fix my outstanding balance into a loan?

U.S. Bank offers a Fixed Rate Option that allows you to convert all or any portion of your credit line balance into an installment loan with a fixed interest rate and a fixed payment schedule.

Can you sell your house if you have a HELOC?

You don’t have to pay off your home equity line or other liens in order to list your home for sale. At your home’s sale closing, any creditors holding liens on your home’s title will be paid off from the proceeds of the sale.

Helocs let you borrow as little or as much you want (up to a limit) much like a credit card. At the same time, like a primary mortgage or a

All this makes Helocs a popular option to pay for large expenses like a major home renovation, or just as a supplement to an emergency fund. At the same time, Helocs come with a big risk. Because you are borrowing against your home, you could stand to lose it if you fail to repay what you owe.

Here’s how a Heloc works, why repayments can be unpredictable and how to shop for the best rates.

What are Heloc interest rates?

Heloc’s may charge slightly higher interest rates than a comparable first mortgage—but they are far cheaper than a credit card. Remember that unlike popular 30-year fixed-rate mortgages, most Helocs have floating rates.

How a Heloc works

In many ways, a Heloc works like a credit card, albeit one backed by your home. After evaluating your financial profile, a lender extends a line of credit to you based on factors including your credit score and how much other debt you have—in the case of a Heloc, looking at your home’s loan-to-value ratio.

Most lenders will cap your total borrowed amount—your primary mortgage plus the amount you can get through a Heloc—at 80% to 85% of your home’s value. This ensures you still have about 15% to 20% equity in the home.

The process of applying for a Heloc—from filling out an application to paying closing costs—can take anywhere from a couple of weeks to over a month. Once in place, however, you can then use the line of credit to cover your spending whenever you need extra cash until you’ve borrowed the maximum. 

There are some key differences between the mechanics of credit cards and Helocs. With a credit card, you can carry a balance indefinitely—as long as you don’t mind being on the hook for the interest that collects. 

By contrast Helocs aren’t designed to let you borrow money forever. Instead you are permitted to borrow during what is known as the “draw period,” which usually lasts for 10 years. During the draw period you make monthly payments to the bank to cover interest on whatever you have borrowed, but you don’t need to pay the principal. 

Once the draw period ends, you start paying back the principal, along with any additional interest that accrues while you are paying off the remaining balance.  

Heloc interest rates

If you own your home and you are willing to use it as collateral, a Heloc can be a cost-effective way to borrow. 

Heloc interest rates are usually in line with mortgage rates. However, you should expect to pay a bit more because Helocs are riskier for lenders, says Robert Heck, vice president of mortgage at Morty, an online broker. If you do end up defaulting on your loan, the Heloc lender won’t get paid back until after your primary mortgage lender has. 

All the same, Helocs are far cheaper than credit cards, even for borrowers with strong credit scores. In November, when the average mortgage rate was around 7%, most credit cards were charging customers between 18% and 25%.

Most Helocs have floating interest rates

Most lenders only offer variable-rate Helocs, where the interest rate changes based on prevailing market rates, sometimes as often as every month. 

Heloc rates are typically determined by the prime rate, which is the short-term interest rate that banks charge their most trustworthy customers. That rate is influenced by the federal-funds rate—the benchmark rate the Federal Reserve sets and uses to cool or stimulate the economy. 

Say you borrow $10,000 from a Heloc and your annual percentage rate when you take out the Heloc is 5% (APR is the interest rate plus any fees tacked on by the lender). You would owe about $42 a month during the 10-year draw period. If interest rates climbed to 7% a year later, your payment would rise to $58 a month until the end of the draw period—unless interest rates move again.

To save money on interest and avoid future payment shock if rates rise, you can choose to fully repay principal and interest during the draw period. This also replenishes the amount you’ve borrowed so you can return to the well and borrow more.

Helocs vs. credit cards

Helocs and credit cards are both ways to set up a so-called “revolving” line of credit which allows you to take whatever you need, whenever you need it—up to a certain limit. 

There’s one major difference between a credit card and a Heloc. A Heloc involves collateral: your house. This is called secured debt, and it means that if you don’t repay what you owe, the bank can take your property. 

Secured debt is less risky for the bank, since it can guarantee it’ll be repaid in some way, even if it comes to selling your house. As a result, the cost of borrowing—that is, your interest rate—is typically lower on a secured loan like a Heloc. 

At the same time, secured debt is riskier to you, the borrower, because there’s a lot on the line. Just three months of missed payments can kick off the home foreclosure process.

Most credit cards are a form of unsecured debt. If you don’t make payments, your credit score and future borrowing potential will suffer—and depending on the size of your unpaid balance, the bank could take legal action against you. But, you won’t have to hand over a physical asset. (Secured credit cards are an option for people with limited credit history; they require a cash down payment.)

Helocs vs. home equity loans

Home equity loans and Helocs are strategies for pulling cash out of your home. But a home equity loan gives you a lump sum that you might use toward one big purchase and start repaying immediately. A Heloc is like an instant rainy day fund, available whenever you need to tap it. 

A home equity loan is often referred to as a second mortgage. You’re responsible for monthly principal and interest payments, in addition to your primary mortgage. A Heloc is more like a credit card. You will have a credit limit, but only pay interest on the amounts you actually borrow. What’s more, a Heloc only requires partial payments while you have access to the line of credit. When that window closes, you’ll have to make full principal and interest payments.

Both strategies require an appraisal to determine your property value and an evaluation of your financial profile and existing mortgage debt to calculate how much you can borrow. In either case, the outstanding debt has to be repaid by the due date or when you sell or refinance the house, whichever happens first.

Scott Fligel, a financial planner with Northwestern Mutual based in Charlotte, N.C., says he most often sees clients using home equity loans for large purchases, such as renovating a kitchen or building a pool. Consolidating credit card debt is another common use, since rates on credit cards can be as much as double what they are on home equity loans.

A Heloc can be used in many of the same situations. But it gives you something like a grace period to borrow as much money as you need, exactly when you need it, without the initial outlay of a home equity loan.

“As long as you’re keeping up with the interest, then you’ve got a lot of flexibility on the timing of when you pay back the principal on the loan,” says Eric Alexander, a financial advisor at Benchmark Income Group in Dallas. This option may be good for someone who has inconsistent income or is using their Heloc proceeds to buy an investment property that won’t generate much cash for the first few years, he says.

Shopping for the best Heloc rates

To find the best Heloc rates, Heck suggests exploring loan options from four to five lenders, including a credit union, a traditional bank, your existing mortgage lender and an online lender. Be sure to compare interest rates and APRs, and dig into the guidelines around rate changes, including the timing and the maximum possible increase (these are often called rate caps). 

“I definitely think that there’s a lot of opportunity to shop, to get lower interest rates that are gonna actually be closer to what you would find on a primary mortgage from some providers,” Heck says. 

In general, the higher your credit score and lower your debt-to-income ratio, the more attractive your interest rate offers will be. 

Be sure to ask about the loan’s structure up front, Alexander says. In some cases, you may be able to switch from a fixed to variable rate, or vice versa, during the repayment period.

The advice, recommendations or rankings expressed in this article are those of the Buy Side from WSJ editorial team, and have not been reviewed or endorsed by our commercial partners.

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