Home Equity Loans and HELOCs Explained
Home equity loans and HELOCs let you borrow against the part of your home you own. This guide explains how much you can borrow, how a lump-sum home equity loan differs from a HELOC line of credit and a cash-out refinance, typical uses, the costs and risks, the tax rules and how to compare lenders.
By Pond.com editors Updated 4 min read
Quick answer
- Home equity is your home's value minus what you owe on it.
- Lenders usually let you borrow until your total debt on the home reaches about 80% to 85% of its value.
- A home equity loan is a lump sum with a fixed rate; a HELOC is a credit line with a variable rate that you draw on as needed.
- Both are secured by your home, so you could lose it if you can't repay.
- Interest is only tax-deductible if you use the money to buy, build or substantially improve the home.
If you've paid down your mortgage or your home has gone up in value, you may have a lot of money tied up in it. A home equity loan or a HELOC lets you borrow against that value, usually at a lower rate than a personal loan or credit card. The catch is that your home secures the debt.
This guide is general information, not financial or tax advice.
How much can you borrow?
Equity is what your home is worth minus what you owe. Lenders usually let you borrow until all the loans on the home add up to about 80% to 85% of its value, though some go higher.
Example: your home is worth $400,000 and you owe $220,000.
- 85% of $400,000 = $340,000
- $340,000 − $220,000 = up to $120,000 you might borrow
Lenders also look at your credit score and debt-to-income ratio, just as for a mortgage.
Home equity loan vs HELOC vs cash-out refinance
| Home equity loan | HELOC | Cash-out refinance | |
|---|---|---|---|
| How you get the money | One lump sum | Draw as needed, up to a limit | One lump sum |
| Rate | Usually fixed | Usually variable | Fixed or adjustable |
| Payments | Fixed, from the start | Often interest-only at first, then higher | One new mortgage payment |
| Your first mortgage | Stays as it is | Stays as it is | Replaced by a new, larger loan |
| Best for | A one-time cost you know | Ongoing or uncertain costs | When new mortgage rates are lower than your current rate |
How a home equity loan works
You borrow a fixed amount, get it all at once and repay it in equal monthly payments over a set term, often 5 to 30 years. Because the rate is fixed, you know exactly what you'll pay, which suits a one-time cost like a roof or a big repair.
How a HELOC works
A home equity line of credit (HELOC) works more like a credit card secured by your home:
- Draw period, often 10 years: borrow, repay and borrow again up to your limit. Many HELOCs only require interest payments during this time.
- Repayment period, often up to 20 years: you can no longer borrow, and you repay the balance with interest.
The rate is usually variable, set at the prime rate plus a margin, so your payment can rise when interest rates go up. The jump from interest-only payments to full payments when the draw period ends can be large, so plan for it from the start.
Good and risky uses
Often sensible:
- Home improvements that add value or fix real problems.
- Paying off high-interest debt, if you've dealt with what caused it. See debt consolidation.
Think twice:
- Vacations, cars or everyday spending. You'd be paying for them for years, with your home at risk.
- Investing or anything with an uncertain return.
- Moving credit card debt onto your home and then running the cards up again.
Risks to know
- Your home is the security. If you can't pay, you could face foreclosure, even if your main mortgage is up to date.
- Rates can rise on a HELOC, raising your payments.
- Home values can fall, leaving you owing more than the home is worth and unable to sell or refinance easily.
- Fees: some HELOCs charge annual fees or early closure fees if you close the line within a few years.
Taxes
Interest on a home equity loan or HELOC is only deductible if you use the money to buy, build or substantially improve the home that secures it, you itemize, and your total mortgage debt is within the $750,000 limit. Interest on money used for other things, like paying off credit cards, isn't deductible. Keep receipts for improvement work.
How to get one
- Estimate your equity with recent sale prices in your area.
- Check your credit and work out what you can comfortably repay.
- Compare at least three lenders, including your bank and a local credit union. Compare the APR, the margin over prime for a HELOC, fees, minimum draws and any rate caps.
- Read the terms on draw and repayment periods and early closure fees.
- Use your right to cancel: for a loan on your main home, you usually have three business days after closing to change your mind.
Common questions
It can be. You only borrow what you need as the project goes, rates are usually lower than personal loans or credit cards, and the interest may be tax-deductible for improvements. Plan for the rate to change and for the higher payments once the draw period ends.
Yes. If your home's value falls significantly or your finances change, the lender can freeze or reduce your credit line. Don't rely on an unused HELOC as your only emergency money.
Any balance on a home equity loan or HELOC must be paid off when you sell, usually from the sale proceeds at closing, along with your main mortgage.
Often, though they're usually smaller than for a mortgage, and some lenders waive them. Look for appraisal, origination and title fees, and with a HELOC, annual fees or early closure fees if you close the line within a few years.