A home equity line of credit, or HELOC, is a loan in which the borrower uses the home equity in his or her home to borrow money over a given period of time.

How does a HELOC work?

To apply for a HELOC, you start by checking your credit score, just as you would with a home equity loan. The higher your credit score, the better your rates, and the more likely you are to get approved.

It is important that you research and compare different providers. To make sure you get the best possible interest rate and terms, check out the different loan terms on comparison portals and take advantage of available prequalification offers.

Compile your application materials. Lenders will ask you for different personal information, such as your Social Security number or salary. In addition, of course, you will need to provide information about your home and outstanding mortgages. You may also need to have an appraisal done on your home.

After applying, lenders will run a credit check and should get back to you within a few days. Usually, a hard credit check will be performed, which will temporarily affect your credit score. With an online loan, an occasional soft credit check will be enough, and it is also possible to get approved the same day. Depending on the lender, the money will be available to you in just a few days.

The Two Phases of a HELOC

Unlike a home equity loan, however, you will not get the money transferred all at once. Instead, you will receive the revolving credit in the form of a line of credit for what is called a draw period, during which you can access the money.

Most home equity lines of credit have two phases. In the first phase, which is usually ten years, you are free to use the borrowed money without having to make repayments. Typically, HELOC contracts require small, variable rates as monthly payments during this draw period. Although you often have the option to make additional payments, which helps pay off the loan more quickly.

Once the loan draw period is over, the repayment period begins. This can last up to 20 years, depending on the provider. During this phase, all interest and the borrowed amount are repaid. As interest rates vary with a HELOC, so do the monthly payments. In most cases, extensions are possible after both the drawdown period and the repayment phase in the event of payment difficulties.

What are the Advantages of a Home Equity Line of Credit?

  • HELOC rates are typically lower than credit card interest rates.
  • The upfront costs are lower with HELOC than with home equity loans.
  • If used for home improvement, interest is tax-deductible.
  • Providers often refrain from charging closing costs or reduce them to a minimum.
  • Interest is charged only on the amount of money you actually use.

When Is a HELOC Suitable and for Whom?

Due to the long timeframe in which you can access the money, this loan is especially suitable for people who need money repeatedly or over a long period of time. Also, because a HELOC is usually not earmarked, you can use the borrowed money in a variety of ways.

For example, a HELOC can be a good option if you have large or ongoing medical expenses and cannot handle the high costs yourself, which is why you want to take advantage of low-interest rates. Due to their very long repayment period, HELOCs are particularly also appropriate for large purchases or expenses like tuition. In addition, a HELOC can be used to consolidate credit card debt, which typically has higher interest rates.

However, be careful not to accumulate more debt during the credit period. Also, you should take into account that repayments do not happen at fixed rates but change over time. Using a HELOC for your home improvement projects is especially useful. Increasing the value of your property directly affects the equity of the home and the interest rates are tax-deductible.

Use your Home Equity for a Credit Line

Like home equity loans, HELOCs are a great way for homeowners to get cash. With relatively low-interest rates and the possibility to borrow only the money you actually need, home equity lines of credit offer real value.

However, compared with a personal loan, HELOCs have some downsides. Read our comparison between home equity loans, HELOCs, and personal loans to make a wise decision for your personal situation.