A HELOC is a revolving form of credit with a variable interest rate, like a credit card. It allows you to
borrow and repay funds on an as-needed basis during a specified period. After that, you pay back the
amount you borrowed in installments. Your home is the collateral for the line of credit, which means
falling behind on payments puts your home at risk of foreclosure.
So, how does a HELOC work, specifically? When you’re approved for a HELOC, you’ll be given a credit
limit based on your available home equity. Typically, you can borrow up to 85 percent of your home’s
value, minus outstanding mortgage balances.
During the draw period, you can use funds from the HELOC using dedicated checks or a draw card. You’ll
need to make monthly interest payments on the amount you borrow, but as you pay back your HELOC,
the funds are replenished. This draw period typically lasts 10 years.
After that, you’ll enter a repayment period, during which you’ll no longer be able to access funds and
instead need to repay the principal and any outstanding interest. Most HELOC plans allow you to repay
the remaining balance over a period of 10 years to 20 years.
While you’ll only be on the hook for interest payments during the draw period, you can pay both
principal and interest at this time if you choose. This can help keep your payments manageable when
you enter the repayment term.
How do you calculate the borrowing limit for a HELOC?
When considering your HELOC application, lenders use your total equity in your house — your
ownership stake — to calculate your loan-to-value ratio, or LTV, which factors into how much you can
borrow.
Say your home is appraised at $375,000 and your outstanding mortgage balance is $150,000. Your total
equity, then, is $225,000 ($375,000 – $150,000). You’d then divide your mortgage balance by the
appraised value to determine your LTV. In this example, your LTV would be 40 percent and your total
equity would be 60 percent.
With a HELOC, you can usually borrow up to 85 to 90 percent of your combined LTV, meaning your LTV
minus the amount still owed on your mortgage and the total credit line of the HELOC you’re seeking.
To calculate your maximum HELOC balance, you can multiply your home’s value by the percentage of
equity you’re tapping and subtract your outstanding mortgage debt. Or as a math equation:
(Your home’s value x the percentage of equity you’re tapping) – how much you owe on your mortgage =
your maximum HELOC balance
Say your bank allows you to draw up to 85 percent of your home’s equity, and your house is worth
$460,000. You still owe $250,000 on your mortgage. That means you could get a HELOC of $141,000
maximum ([$460,000 x 0.85] – $250,000 = $141,000).
Of course, this is a generic example. Factors such as your credit score, financial situation and bank
policies could also affect the maximum limit the lender sets for your HELOC.

• What are the pros and cons of a HELOC?
• Pros of HELOCs
• Flexibility: While you’ll be approved for a maximum HELOC amount, you don’t need to use all of
• it. This makes HELOCs an attractive option for paying for ongoing expenses, as well as a “nice to
  have” for unforeseen emergencies.
• Interest-only payments: During the draw period (the first 10 years), you’re only required to pay
  interest on what you use from the line of credit. This keeps your payments low, freeing up cash
  for other expenses or goals.
• Lower rates: HELOCs are backed by the equity in your home, which acts as collateral for the debt
  (in contrast to unsecured debt instruments, like credit cards or some personal loans, which
  aren’t backed by anything). The presence of collateral makes a loan less risky to a lender.
• Because of this lower risk, HELOCs and home equity loans tend to have lower rates than these
  other types of financing.
• Potential tax deduction: If you use the funds from a HELOC to make home improvements, you
  might be able to deduct the interest on your tax return.
  Cons of HELOCs
• Variable rates: HELOCs have a variable interest rate, which means the rate can go up or down
  depending on the economy and prevailing market rates. If your rate goes up significantly, you
  might no longer be able to manage the payments.
• Secured by your home: A HELOC is tied to the equity in your home, so if you default on your
  payments, it could be foreclosed on by your lender.
• Sudden repayment shock: You might be able to afford your HELOC payments during the
  interest-only period, but once the repayment term kicks in, the new monthly amount you owe, a
  combination of principal and interest payments, could squeeze your budget.
• Sensitive to the real estate market: A significant decline in home values could cause your lender
  to reduce or freeze your credit line (during the draw period).
  When is it a good idea to get a HELOC?
• A HELOC can make a lot of sense if you have a solid purpose for the funds. Some of those purposes may
  include:
• Use the money to pay off high-interest credit card debt
• Tackle home improvements (and get a tax deduction perk, too)
• Pay for education
• Fund emergency expenses (e.g., car repairs, medical bills)
• Ultimately, there are several use cases where a home equity line of credit can make financial sense. Just
  remember that your home serves as collateral, so it isn’t worth taking out the HELOC if you’re not
  confident you’ll be able to repay what you borrow.

How do you qualify for a HELOC?
Applying for a HELOC is a lot like applying for a traditional mortgage and there’s no one-size-fits
all set of requirements to qualify for a HELOC. That said, the criteria commonly include:
Amount of home equity: Lenders typically require homeowners to have at least 15 percent to 20
percent equity (the portion of your home you own outright).
Credit score: Homeowners generally need a credit score in the mid-600s to qualify for a HELOC.
If you’re approved with a lower credit score, you’ll likely have a higher interest rate.
DTI ratio: Many lenders want to see a debt-to-income (DTI) ratio of 43 percent or less. However,
certain lenders might approve you with a DTI ratio of up to 50 percent.
How do HELOC interest rates work?
You’ll almost always encounter variable interest rates with HELOCs, but a few lenders also offer fixed-
rate versions.
Variable interest rates
Variable interest rates on HELOCs are partly determined by benchmark indexes, like the U.S. prime rate.
The prime rate is set by individual banks and influenced by fluctuations in the federal funds rate (the
rate that banks charge other banks for short-term loans).
Because market conditions can cause the prime rate to fluctuate, your HELOC interest rate can also
increase or decrease over time. As a result, your monthly payment can change. However, your lender
will generally cap how much your rate can increase over the HELOC’s lifetime.
Fixed interest rates
Some lenders offer fixed-rate HELOCs, which allow you to lock in a portion of your HELOC balance with a
set, unchanging interest rate. This essentially converts part of your HELOC into a home equity loan. With
a fixed rate, you won’t need to worry about your interest rate increasing or decreasing with market
fluctuations.
Typically, you’ll repay that portion of the loan over a period of five to 30 years, though the balance must
be repaid by the end of your normal HELOC repayment period. If you’re interested in this option, look
for lenders advertising “hybrid HELOCs” or fixed-rate locks.