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A home equity line of credit — HELOC for short — is a credit line against your home equity. It works like a credit card at first: You can use the line as needed and pay interest only on the amount charged, and a HELOC’s rates are typically variable.
Most HELOC lenders offer an interest-only payment option for the first 10 years of the credit line (known as the “draw period”). You’ll pay the monthly interest charges only, but the balance owed stays the same. When the draw period ends, the “repayment period” begins, and any balance due is typically repaid over a 15- to 20-year term in fixed installments.
The term “interest-only HELOC” refers to the interest-only option most HELOC lenders offer with a home equity line of credit. Some borrowers prefer to make regular principal and interest payments to reduce their loan balance. However, the interest-only option comes in handy if you need short-term payment savings and plan to pay off the balance quickly.
Most HELOC rates are tied to the prime rate, a variable interest rate that’s determined by individual banks. Many banks set their prime rates based on the federal funds rate targets established by the Federal Reserve — though this makes them more volatile, especially in rising rate environments.
There are a number of factors that determine home equity line of credit rates.
Pros and Cons of HELOC rates
| Pros | Cons |
|---|---|
| You’re only charged interest on the amount you use | Your rate is variable and could increase over time |
| You don’t pay any interest on the unused portion of your credit line | You’ll need a higher credit score than standard loans to get the best rate |
| You can make interest-only payments if your lender offers the option | After the interest-only draw period ends, a balloon payment may be due, making the HELOC unaffordable |
| Your lender may offer a low introductory rate for the first six months | You may have to pay annual membership and maintenance fees |
| You can deduct mortgage interest on your taxes if HELOC funds go toward home improvements | You could lose your home if you can’t repay the balance owed |
A HELOC can help you accomplish a variety of financial goals. It may make sense to take out a HELOC if:
Keep in mind that getting a HELOC means you’re using your home as collateral to secure the credit line. If you plan to sell your home in the near future, you’ll make less on the sale if you borrow against your home equity. And if you fall on hard financial times, you could lose your home to foreclosure if you fail to repay what you owe.
If you prefer the stability of a fixed-rate payment and don’t mind receiving the entire loan balance in one lump sum, check out a home equity loan.
You should know that home equity loan rates are typically higher than HELOC rates and often don’t come with an interest-only payment option. But despite the higher rates, a home equity loan may be worth it if:
You’ll typically pay a significantly lower fixed rate for a cash-out refinance than you will for a HELOC. A cash-out refinance is taking out a new mortgage at a larger loan amount than you currently owe and pocketing the difference. Since it’s a “first” mortgage, lenders typically offer lower rates because they know they’ll be first in line to be repaid if you can’t make your payments and they have to foreclose on your home.
A HELOC, on the other hand, is a “second” mortgage, and HELOC lenders are paid after the first mortgage in a foreclosure, which could be risky if home values have dropped. HELOC lenders offset that risk by charging higher interest rates.
Use the table below to help you decide if a HELOC, home equity loan or cash-out refinance rate is a match for your financial plans.
| Interest rate features | HELOC | Home equity loan | Cash-out refinance |
|---|---|---|---|
| Fixed or variable | Variable | Fixed | Fixed* |
| Interest-only payment option? | Yes | No | No |
| Rate competitiveness | Higher rates than cash-out refinance loans; lower rates than home equity loans | Higher rates than home equity and cash-out refinance loans | Lower rates than HELOCs and home equity loans |
| Interest rate charges | Charged on balance used during draw period | Charged monthly immediately after loan closes | Charged monthly immediately after loan closes |
“Since the start of the year, HELOC rates have risen and they will likely remain where they are — or even rise a bit higher — over the coming months as the economy continues to deal with high inflation,” said Jacob Channel, LendingTree’s senior economist.
Despite this recent rise in HELOC rates, Channel also notes that HELOCs are a great option to get some extra cash for Americans who are sitting on record amounts of home equity.
Yes, if you use the credit line to meet short-term financing goals that will help improve your overall financial picture and fully understand the HELOC’s repayment terms. Always shop around for HELOC rates and quotes with multiple lenders.
There may be a slight drop in your score when you apply for a HELOC, but if you apply with multiple lenders within a 45-day window, the credit checks usually count as one inquiry, according to the Consumer Financial Protection Bureau (CFPB).
You may need a home appraisal, although some lenders may waive the requirement.
Closing costs typically equal 2% to 5% of the total line of credit.
Interest on a HELOC may be deductible if the money you tap is used for home improvement projects.
Yes, but you’ll typically pay a higher interest rate — that means your payment on the amount you draw will be higher than a comparable, variable-rate HELOC. However, you won’t have to worry about rising rates in the future, which is especially important if you’re living on a fixed income.