How Does a HELOC Work?

A home equity line of credit (HELOC) is a credit line secured by the equity you have in your home. You can borrow from it over several years and will only pay interest on the funds you’ve withdrawn. When the draw period is up, you’ll repay the outstanding amount, often over a term of 10 to 20 years.

HELOCs offer a sizable chunk of change that can help you accomplish goals like completing home improvement projects or paying off high-interest debt. But how exactly do they work in terms of the application process, draw period, interest calculations, and repayments? Here’s what you should know.

Key Takeaways

To apply for a HELOC, you’ll need to undergo a credit check, provide your personal information, share your property details, and have your home appraised.
HELOCs can range from approximately $10,000 up to $1 million.
HELOC draw periods often last five to 10 years.
Repayment periods often last from 10 to 20 years.
You only pay interest on the amounts you withdraw from the credit line until those funds are repaid.

How To Apply for a HELOC

While many banks and credit unions offer HELOCs, the rates, terms, and eligibility requirements will vary from one lender to the next. It’s a good idea to shop around to find at least three HELOC lenders that match your needs, then apply to find out what they’ll offer you.

Here’s a look at how the application process works.

Share Your Loan Needs

First, you’ll usually need to share your desired HELOC amount and how you plan to use the funds (e.g., debt consolidation, home renovation)

Share Your Personal Information

Next, just like with any loan, you’ll need to provide the lender with personal information. For example, your name, address, phone number, citizenship status, marital status, and Social Security number. You’ll also need to share your employment status and income information.

Note

If you’re applying with a co-signer, you’ll need to provide all of the above information for them as well.

Share Your Property Information

A HELOC is secured by a home, so the lender will want to know about your collateral. Be ready to provide your:

Property address
Purchase date
Original purchase price
How the property is used (primary residence, secondary residence, etc.)
Mortgage payment amount
Outstanding mortgage balance
Property taxes
Homeowners insurance

Lenders may also have questions such as whether you have flood insurance, if you pay HOA fees, and if there’s a homestead right on the property. They need to get a full understanding of your property’s value.

Submit Your Application for Review

Once you’ve provided all the required information, you’ll submit it for verification and review. At this point, the lender will usually check your credit. From there, you’ll be able to review your loan options.

Note

Once you decide to go ahead with a particular HELOC, the lender will verify your income by reviewing bank accounts, pay stubs, and/or tax returns. Further, they’ll appraise the current value of your home, which may or may not require a visit from an appraiser.

How To Qualify for a HELOC

What does it take to qualify for a HELOC? Here are some of the common requirements:

Sufficient home equity: A minimum amount of equity is required, which may be a minimum dollar amount or a minimum equity percentage. For example, PenFed’s minimum HELOC amount is $25,000, so you would need to have at least $25,000 in available equity. On the other hand, Rocket Mortgage recommends you own at least 15%-20% of your home before applying.
Low debt-to-income (DTI) ratio: Your DTI ratio can’t be too high. For example, at PenFed, you must have a DTI of 50% or less.To figure out yours, divide your monthly debts by your monthly income.
Stable income: Lenders also look for a stable source of income to prove you’ll be able to repay the HELOC without difficulty.
Good credit score: Lenders will review your credit report and score. The higher your score and fewer missed payments you have, the easier it will be to get approved.

Save time by doing a little research before applying, to find out if you meet a lender’s eligibility requirements. Make sure they are a match in terms of credit score requirements, credit line amounts, DTI, income, and home equity requirements.

Drawing on Your Home Equity With a HELOC

The draw period is the window of time when you’re allowed to withdraw money from your HELOC. It often ranges from five to 10 years. You can continue to make withdrawals until you hit your credit limit or your draw period ends. If you hit your limit but still have time left, you’ll need to pay off a portion of the balance before you can borrow more.

But how do you actually get access to the money from the credit line? Common methods include via:

Check
Online bank transfer
Visit to a branch
Credit card linked to the HELOC

As for the time it takes to get your funds, it will depend on the lender and the withdrawal methods available. For example, some banks enable free, same-day transfers to your checking account while others may take a week to mail you a check.

Note

While you can withdraw the full amount of your credit line upfront, it’s best to withdraw it as you need it, to save on interest expense.

How Is HELOC Interest Calculated?

HELOC interest is often calculated each day by multiplying your outstanding daily balance by 1/365th of your annual percentage rate (APR)—known as the daily periodic rate.

The HELOC interest formula is as follows:

Outstanding HELOC balance x Daily periodic rate = Interest owed per day

The interest costs per day are then added up each month and sent to you in your monthly statement. If you aren’t sure what your APR is, you can check your latest statement or contact your bank to request it.

HELOC Interest Example

Let’s say you qualify for a $100,000 HELOC with a 3.59% APR. You withdraw the full $100,000 and don’t repay any of it off during the first month. Your interest cost per day would be the 3.59% APR divided by 365, which gives you a 0.00983562% daily periodic rate. Then, you would multiply your outstanding balance ($100,000) by the daily periodic rate to figure out how much you owe per day ($9.84).

If there were 30 days in the current month, your interest charges at the end of the month would be $295.20.

HELOC Outstanding Balance	APR	Daily Periodic Rate	Interest per Day	Days in Month	Interest per Month
$100,000	3.59%	0.00983562%	$9.84	30	$295.20

How Does HELOC Repayment Work?

When a HELOC’s draw period ends, your outstanding balance may become due all at once, or you may enter a repayment period. If you have a repayment period, your outstanding balance will get structured like a term loan that’s repaid through monthly payments (with interest). Common terms range from 10 to 20 years.

Note

If you’re late on a HELOC payment, you could face late fees and damage to your credit. If you miss payments and default, your house will be at risk because it serves as collateral for the credit line. In other words, your lender may foreclose on your home.

Can I Repay My HELOC Early?

If you repay your balance during the draw period, it will stop you from accruing more interest charges and will make your credit line available again—just like a credit card. Once the repayment period begins, you can also usually pay off the balance early to save on interest, but your credit line will no longer be reinstated.

Note

While prepayment penalties are rare, your HELOC may have an early closure fee, which is charged if you close the credit line early. For example, U.S. Bank charges 1% of the original credit line amount, up to $500, if a HELOC is closed within the first 30 months.

Frequently Asked Questions (FAQs)

How much can I get with a HELOC?

The amount you can borrow with a HELOC depends on the lender’s loan limits, the amount of equity you have in your home, and other factors such as your credit and income. HELOC limits from banks and credit unions can range from about $10,000 up to $1 million.

How do you use a HELOC to pay off your mortgage?

If you can qualify for a HELOC that’s large enough, you could use it to pay off your mortgage. To do so, transfer the funds from your credit line to your checking account, ask your mortgage lender for a pay-off letter that shows the amount owed, and make the payment to your mortgage lender.

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