How does a HELOC work?

A home equity line of credit (HELOC) is a flexible financing solution that works as a revolving line of credit. It has two phases: the draw period and the repayment period. During the draw period, you can borrow as needed up to your approved limit. You then enter the repayment period, where you repay the principal and interest through monthly payments. Check with your lender to see if there are any costs in opening a home equity line of credit as some lenders have none.

Because a HELOC is backed by the equity in your home, it may offer a lower interest rate than other financing options, like credit cards and personal loans. That's why many homeowners use HELOCs to finance home renovations, consolidate debt, pay educational expenses or fund other financial goals.

How does a HELOC work? Learn about requirements, HELOC draw and repayment periods and how to apply.

Requirements and application for a HELOC

The requirements for a HELOC vary depending on the lender. Most require that you have at least 15% to 20% equity in your home and a credit score of 680 or higher. Lenders also typically look for a debt-to-income ratio of 55% or lower, meaning no more than 55% of your gross monthly income is used to pay your monthly debts.

The amount you can borrow with a HELOC varies depending on the lender, and the application process is similar to applying for other loans:

1. Submit an application
2. Provide financial information
3. Go through loan underwriting
4. Close on the loan

With most lenders, you can apply for a HELOC online, by phone or in person at a branch. It typically takes two to six weeks to close on the line of credit. Be sure to gather your documents before applying to prevent delays.

You'll need:

• Government-issued photo ID
• Proof of income
• Employment information
• Bank statements
• Existing debt information
• Property information

HELOC draw period

With a HELOC, you can draw funds as needed up to your credit limit for 10 years or less depending on the lender. This is the draw period. Your available credit is replenished when you repay the money you borrow, and you may qualify for tax benefits for some home improvements depending on where you live.

HELOC funds can be accessed through:

• Online or mobile transfers
• Cash withdrawals
• Writing checks

You can make interest-only payments during the HELOC draw period, or you can choose to pay more. HELOCs also have variable rates during this time. This means your payments could increase or decrease depending on market conditions and actions by the Federal Reserve.

Many homeowners use HELOCs to finance home renovations that are completed in stages. For example, you might draw funds for a new HVAC system and later access additional funds for new windows and solar panels to make your home more energy efficient.

HELOC repayment period

When the draw period ends, you enter the repayment period, which typically lasts 10-20 years. You are no longer able to draw from the HELOC, and the remaining balance is amortized with fixed monthly payments.

If you made interest-only payments during the draw period, your payments will likely increase during the repayment period. That's because you will be repaying the principal and interest during this time.

For example, suppose you drew $20,000, and the interest rate is 8%. If you make interest-only payments during the draw period, you'll pay $133.33 per month, assuming the rate doesn't change. When you transition into a 10-year repayment period, your payments will increase to $242.66, as you will be repaying the principal and interest.

Get started with a HELOC

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