HELOC: a home equity line of credit, in plain words.
A HELOC is a home equity line of credit: a line you can borrow from as you need it, secured by the equity in your home. It is a second loan, so your current mortgage stays as it is. This page explains the draw period, the repayment period, how a HELOC differs from a cash-out refinance, and the risks. It quotes no rates.
Sam Batayneh is a mortgage loan originator (NMLS 332474) and VP of Mortgage Lending at OriginPoint (NMLS 1598647). Sam has originated mortgages since 2004 and lends in all of California. OriginPoint lists HELOCs among its loan options.
What is a HELOC?
A line of credit secured by your home. You borrow from it as you need to, up to a limit, and pay interest on what you have borrowed.
Equity is the part of your home that you own outright: what the home is worth, less what you owe on it. A HELOC lets you borrow against some of that equity without selling the home and without replacing the mortgage you already have.
It works more like a credit line than like a mortgage. The lender sets a limit. You draw what you need, when you need it, and you owe interest only on the amount you have drawn. Pay some back and that room is there to borrow again, for as long as the line is open.
A HELOC is a second loan on your home. The first mortgage keeps its own rate, term and payment, and the HELOC sits behind it with its own. That is the main reason people look at one: they would rather not disturb the loan they have.
The home is the security for both loans. However flexible it feels, a HELOC is a debt against the house, and it has to be repaid when the home is sold.
How do the draw period and the repayment period work?
A HELOC usually has two stages. First you can borrow; then you can only repay. The payment often goes up when the second stage begins.
The draw period
The line is open. You can borrow, repay and borrow again, up to the limit. Many lines ask for payments of interest only on what you have drawn.
The repayment period
The line closes to new borrowing. What you owe is repaid with interest over the years that remain, so each payment now includes principal.
The change between the two stages is the part to plan for. A payment that covered interest alone becomes a payment of principal and interest, and it can be noticeably larger. The length of each stage is written in the HELOC agreement.
Many HELOCs also have a rate that can change. It follows a published index plus a margin, much as an adjustable-rate mortgage does, so the payment can move during either stage. How an index and a margin work on an adjustable-rate mortgage.
What are the risks of a HELOC?
Your home secures the line, the payment can change, and it usually goes up when the repayment period begins. Six things to weigh.
- Your home is the security. Falling behind on a HELOC can put the home at risk, as with any loan secured by it.
- The payment can change. Many HELOCs follow an index, so the payment can go up while you still owe the same amount.
- The payment steps up. When the draw period ends, payments start to include principal.
- It is easy to borrow. A line that is simple to draw on is simple to overuse. Borrow against a plan, not against the limit.
- The line can change. A lender can reduce or freeze a line in some situations, such as a marked fall in the home’s value.
- Selling or refinancing. A HELOC has to be paid off when the home is sold, and it has to be dealt with if you refinance the first mortgage.
How does a HELOC differ from a home equity loan and a cash-out refinance?
A HELOC is a line you draw from. A home equity loan is one sum. A cash-out refinance replaces your mortgage with a larger one. The first two leave your current mortgage alone.
HELOC
A second loan. You borrow as you need to during the draw period, often at a rate that can change. Your first mortgage is not touched.
Home equity loan
A second mortgage paid in one amount at the start and repaid in level payments. Your first mortgage is not touched.
Cash-out refinance
Your mortgage is replaced with a larger one and you receive the difference. The whole balance moves to the new loan’s rate and term.
The choice often comes down to the mortgage you already have. If you would rather keep it exactly as it is, a second loan leaves it alone. If you would replace it anyway, a cash-out refinance does both jobs with one loan and one payment. Ask Sam to lay the options side by side. HELOC or cash-out refinance, on the Refinance page.
OriginPoint lists HELOCs and cash-out refinances among its options. A home equity loan is described here for comparison only. OriginPoint publishes its own conditions and disclosures for each program, and those apply in full: ask Sam for them.
What do lenders usually look at on a HELOC?
Your equity, your income and debts, your credit and the home’s value. This is a general list, not OriginPoint’s requirements.
- Equity. What the home is worth against everything owed on it, the new line included. Lenders set a ceiling on the total.
- Your current loan. A recent mortgage statement, and one for any other loan on the home.
- Income. Pay stubs and W-2s, or tax returns for self-employment, as on a mortgage.
- Credit. Your credit history, and your monthly debts measured against your income.
- The home’s value. An appraisal, or another valuation the lender accepts.
- How the home is used. A main home, a second home or a rental. The rules differ for each.
What do homeowners commonly use a HELOC for?
Costs that arrive in stages or at uncertain times, where a line suits better than one sum. These are common uses, not recommendations.
Renovations
Building work is paid in stages, and a line can be drawn as the bills arrive. For a large project, compare it with a renovation loan.
Bridging a move
Some owners draw on the equity in a current home toward the next one. OriginPoint also has a program called Buy Before You Sell.
A reserve
Some owners open a line and leave it undrawn. Interest is owed only on what is borrowed, though a line can carry fees.
Program names are OriginPoint’s. Which one fits depends on your own file, and naming a program here is not a promise that a loan will be approved. Whether interest on a HELOC can be deducted is a tax question for your own CPA.
Plain answers about HELOCs.
What is a HELOC?
How does a HELOC work?
What is the difference between a HELOC and a cash-out refinance?
What is the difference between a HELOC and a home equity loan?
What are the risks of a HELOC?
General education only. Each lender sets its own rules, and they change. Nothing here is a promise that a loan will be approved or of any terms. This is not tax, legal or investment advice: for those questions, ask your own CPA, attorney or business manager.
Thinking about a HELOC?
Tell Sam what you owe, what the home is worth and what the money is for. Sam will lay a HELOC beside the other ways to use your equity.