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If you have more than 20% home equity and a credit score of at least 620, you may qualify for a home equity line of credit (HELOC). A HELOC is a convenient and often inexpensive way to borrow money using your home’s value as collateral. Let’s look at how a HELOC works and whether its features might make it a good or bad option for you.

Key Takeaways

  • During its draw period, a HELOC works much like a credit card, allowing you to borrow and repay sums as needed and make minimum monthly payments.
  • Compared with a credit card, a HELOC’s interest rates can be significantly lower, and the loan has a defined term that requires you to repay everything you’ve borrowed by a certain date.
  • Your home equity is the collateral for a HELOC, so if you can’t repay what you’ve borrowed, you could lose your home in foreclosure.

How Much Can You Borrow With a HELOC?

The first step in deciding if a HELOC is right for you is knowing whether you have enough home equity to qualify and the amount of the credit line for which you might be eligible. Your home equity is the difference between your home’s appraised value and your mortgage balance (assuming you have an existing mortgage). If your home is worth $500,000 and you owe $250,000, your equity is 50%. If your home is worth $500,000 and you don’t have a mortgage, your equity is 100%.

To estimate how large a credit line a lender might extend you, calculate your combined loan-to-value ratio (CLTV ratio). Most HELOC lenders allow a CLTV of at least 80% on your main home, sometimes higher.

Multiply your home’s value (let’s say it’s $500,000) by 0.8 to get how much debt most lenders will be comfortable letting you carry against your home. In this case it comes to $400,000. Then, subtract the $250,000 you owe on your existing home loan: $400,000 – $250,000 = $150,000. This is how much you can potentially borrow.

Per the Fair Housing Act, mortgage lending discrimination is illegal. If you think you’ve been discriminated against based on “race, color, religion, sex (including gender, gender identity, sexual orientation, and sexual harassment), familial status, national origin, or disability,” there are steps you can take. One such step is to file a report with the Consumer Financial Protection Bureau (CPFB) or the U.S. Department of Housing and Urban Development (HUD).

How Does a HELOC Work?

A HELOC is sort of like a credit card and sort of like a home equity loan. As with the former, it gives you a revolving line of credit and has a variable interest rate. As with the latter, it has a fixed term and a defined repayment period.

With a credit card, the bank gives you a credit limit based on your household income and credit score. In each billing cycle you can spend as much or as little as you want, as long as you stay under that limit. When you get your statement, you have to at least make the minimum monthly payment, but you can also repay the entire balance if you don’t want to accrue interest. After the bank processes your payment, your available credit increases by the amount of your payment that went toward the principal balance.

A HELOC functions similarly, but your credit limit is also based on how much equity you have in your home. Additionally, a HELOC has two periods.

  1. First, there’s a draw period, typically 10 years, during which you can borrow up to your credit limit and make interest-only payments.
  2. Second, there’s a repayment period, generally 20 additional years, when you can no longer borrow money but must repay your outstanding balance with interest.

Here’s what else you should know to decide if a HELOC might be a good choice for you.

What Else Do You Need To Qualify for a HELOC?

You’ll need to document your income as you would if you were applying for any other type of mortgage: with pay stubs, W-2 forms, and income tax returns. By comparison, banks tend to take you at your word when you state your income on a credit card application.

Lenders decide whether you have enough income to qualify for a HELOC by looking at your debt-to-income (DTI) ratio. Many home equity lenders prefer to see a DTI ratio no higher than 43%, meaning that your monthly mortgage, student loan, auto loan, credit card, and proposed home equity loan payments combined should not be more than 43% of your pretax income. Some lenders are more generous, perhaps allowing a DTI as high as 50%.

Are You Comfortable Using Your Home as Collateral?

As a HELOC is secured by your home’s value, if you don’t repay the loan, you could end up in foreclosure. Credit cards or personal loans, on the other hand, are forms of unsecured credit. With unsecured debt, you’re significantly less likely to lose your home if you can’t repay what you borrow. Your creditors could still sue you for nonpayment and possibly win a judgment against you in some states. However, you may be less likely to lose your principal residence when it doesn’t secure your loan.

Will an Unpredictable Interest Rate Stress You Out?

HELOCs, like most credit cards, have variable interest rates that change over time as economic conditions change. When you’re considering a HELOC offer, you’ll want to know the lowest and highest rate you could possibly pay and how often the rate will adjust.

If interest rates increase, will you still be able to afford the monthly payments? A HELOC is more manageable if you keep your borrowing well below your means and have enough flexibility in your budget to deal with fluctuating payments.

Can I Get a Tax Deduction on HELOC Interest?

Unlike the interest on a credit card or an unsecured personal loan, HELOC interest can sometimes be tax deductible, but only if the loan is “used to buy, build, or substantially improve the taxpayer’s home that secures the loan,” according to the Internal Revenue Service (IRS). This provision became law in 2018 under the Tax Cuts and Jobs Act (TCJA) of 2017, and it is currently slated to go away in 2026, unless Congress extends it.

The TCJA also nearly doubled the standard deduction, making it less common for taxpayers to benefit from itemizing their deductions. It’s anyone’s guess what will happen in 2026 and beyond.

Should I Refinance My High-Interest Debt With a HELOC?

Let’s say the annual interest rate on a HELOC is 5% and the interest payments are tax deductible, while the annual interest rate on your credit card debt is 30% and the interest payments are definitely not tax deductible. In this scenario, or even one where the HELOC’s rate goes up to 15%, it’s easy to see how you could potentially save a ton of money and get out of debt faster by using a HELOC to pay off your credit card balances. In effect, you will have swapped a high-interest loan for a low-interest loan.

However, some people will use a HELOC or home equity loan to pay off high-interest debt and then use their newly replenished credit card limits to accumulate even more of it. This is a practice known as “reloading,” and it often doesn’t end well.

Do I Have to Get My HELOC From the Company That Services My First Mortgage?

While you may have received offers to apply for a HELOC from the company to which you send your monthly mortgage payments, you’re free to get a HELOC from any lender. Those offers don’t mean that you’re approved, and you shouldn’t assume you’ll get the best interest rate by sticking with a single lender. Instead, it’s smart to shop around and apply for a HELOC with several lenders to find the least expensive option.

The Bottom Line

If you want to borrow against your home using a HELOC, make sure you understand exactly how it works before you sign the loan paperwork. In particular, you need to know when your interest rate might change and by how much.

Make a spreadsheet and run some calculations to see how much you can afford to borrow against your credit line at different interest rates and how much this form of borrowing might cost you over 10, 20, or 30 years. Also, think about how you plan to use the money and your past borrowing behavior to decide whether a HELOC is likely to help or hurt your finances in the long run.

If you have a habit of using credit to spend beyond your means, you may be better off leaving your home equity intact. Focus on other strategies for paying off your existing debts, such as the debt snowball or debt avalanche methods. You could also refinance your debts with another loan that’s not secured by your home, such as a personal loan or a lower-rate credit card.

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