What is a HELOC and What Can You Use it For?

Credit limit

The financial institution sets the maximum amount you can borrow, known as the credit limit. This limit is typically determined by a combination of your home’s appraised value and the amount of equity you have. Most lenders allow you to borrow up to 80% or 85% of your home value, less your mortgage balance. For example, if your home is valued at $500,000 and you have a $200,000 mortgage balance, your equity is $300,000. In this case, using the home equity loan calculator, your HELOC limit would be $200,000, assuming an 80% loan-to-value ratio.

Draw period

During this period, which normally lasts five to ten years, you borrow up to your credit limit as needed. You are typically required to make interest-only payments on the amount you borrow during this period.  We recommend consulting your lender for detailed information regarding the terms of the draw period.

Repayment period

After the draw period ends, the HELOC enters the repayment phase. During this period, you can no longer draw additional funds and must repay the principal and interest. We advise consulting your lender for precise details regarding the terms of the repayment period.

Variable interest rates

HELOCs generally have variable rates, meaning they fluctuate based on market conditions. While this leads to lower initial rates than fixed-rate loans, it also introduces the risk of increasing rates over time.

Interest is tax deductible for qualifying expenses

If you use the HELOC to fund qualifying expenses that significantly improve your home’s value, such as renovating a kitchen or adding an extra room, the interest paid is tax-deductible (IRS, 2023). For mortgage loans taken out after December 15, 2017, you can deduct interest up to $750,000. But for those taken out before that date, the limit is $1 million. Consult a tax advisor regarding the deductibility of interest.

Uses of a HELOC

You can use funds from a home equity line of credit for various purposes, such as home improvements, debt consolidation, education expenses, or even unexpected emergencies. Notably, a HELOC is a financial superpower used by 38% of Americans in home renovations (TD Bank, 2023). The HELOC’s flexibility makes it an attractive option for many homeowners.

Budget wisely

First and foremost, plan how you will use the funds from your HELOC. In addition, ensure that you can comfortably make the required payments. Avoid using the HELOC for non-essential expenses that could strain your finances.

Track spending

Review your statements regularly to ensure you’re aware of how much you’ve borrowed and how much you owe. This constant monitoring will help you avoid overborrowing and ensure you can manage your payments.

Prioritize payments

During the draw period, focus on making more than the minimum interest-only payments. Paying down the principal during this time can reduce the total interest you’ll pay over the life of the loan. Once the repayment period begins, prioritize repaying the HELOC to minimize long-term costs.

Review interest rates

Since most HELOCs have variable interest rates, stay informed about market conditions. If interest rates rise significantly, consider refinancing your HELOC to a fixed-rate loan or paying down the balance more aggressively.

Plan for repayment

As the draw period ends, be prepared for the repayment period. Understand how your payments will change and have a plan to manage these new obligations. Consider adjusting your budget or increasing your income to accommodate higher payments. 

Overborrowing

Just because you’re approved for a large amount doesn’t mean you should use it all. Draw only what you need and can repay comfortably.

Ignoring fees

HELOCs often have various fees, including annual, maintenance and early termination fees. Be aware of these costs and factor them into your decision-making process. Read the fine print and inquire about any potential fees before you commit.

Neglecting repayments

Failing to make timely payments on your HELOC can result in penalties and higher interest rates. In the worst case, it can end up in foreclosure, where the bank seizes your home. Set up automatic reminders or payments to ensure you never miss a payment. If you’re struggling to make payments, contact your lender to discuss your options.

Variable interest rates

HELOCs typically have variable interest rates, which can increase, leading to higher monthly payments. To mitigate this risk, consider refinancing to a fixed-rate loan if rates rise significantly.

Misusing funds

It’s best to use HELOCs for debt consolidation, home improvements or expenses that provide long-term value. Avoid using the funds for vacations, luxury purchases or speculative investments.

What is a Home Equity Line of Credit (HELOC)?

A Home Equity Line of Credit (HELOC) is a flexible and much larger credit line that allows you to borrow against the home equity you have built up in your property. It functions similarly to a credit card, featuring a maximum credit limit. You can borrow as needed during a draw period, usually with variable interest rates.

How does a HELOC differ from a home equity loan?

A HELOC provides a revolving line of credit with variable interest rates, allowing you to borrow as needed during the draw period and make interest-only payments initially. In contrast, a home equity loan offers a lump sum with a fixed interest rate and fixed monthly payments, making it suitable for one-time, large expenses.

What are the typical repayment terms for a HELOC?

The repayment terms for a HELOC typically consist of two phases: the draw and repayment period. The draw period usually lasts five to ten years, during which you can borrow up to your limit and make interest-only payments. The repayment period follows, often lasting 10-20 years, during which you repay the principal and interest in regular, fixed payments. We advise consulting your lender for comprehensive information regarding both draw and repayment terms and conditions.

Can I pay off my HELOC early without penalty?

Many lenders allow you to pay off your HELOC early without penalty, but it's essential to check the specific terms and conditions of your loan agreement. Some lenders impose early termination fees or prepayment penalties.

What should I consider before applying for a HELOC?

Before applying for a HELOC, consider the following factors:

• Equity in your home: Ensure you have sufficient equity, usually at least 15%-20% of your home's value.
• Credit score: A higher credit score (at least above 620) can help you secure better interest rates and terms.
• Interest rates: Understand that HELOCs typically come with variable rates, which can increase or decrease over time.
• Fees: Be aware of costs associated with the HELOC, such as annual fees, maintenance fees and potential early termination fees.
• Repayment ability: Evaluate your ability to make payments, especially during the repayment period when both principal and interest are due.
• Purpose of the loan: Ensure that the HELOC will be used for significant financial needs, such as home improvements, debt consolidation or emergency expenses, rather than discretionary spending.