HELOC
A Home Equity Line of Credit (HELOC) is a revolving line of credit secured by the equity in a borrower's home, allowing the homeowner to draw, repay, and re-draw funds up to an approved credit limit during a defined draw period, after which outstanding balances must be repaid. HELOCs typically carry variable interest rates tied to a benchmark such as the prime rate.
A HELOC functions similarly to a credit card in its revolving structure, but it is secured by real property rather than being an unsecured credit facility. A lender approves a maximum credit line based on the homeowner's available equity, creditworthiness, and income, and the homeowner can draw from this line at any time during the draw period — typically 10 years. During the draw period, borrowers are usually required to make interest-only payments on the outstanding balance, though many lenders also permit or encourage principal payments. When the draw period ends, the repayment period begins — typically an additional 10 to 20 years — during which the borrower must repay the outstanding balance, typically through fully amortizing monthly payments.
HELOC interest rates are almost universally variable in the U.S. market, typically indexed to the Wall Street Journal Prime Rate (which in turn tracks the federal funds rate target set by the Federal Open Market Committee of the Federal Reserve) with an added margin. A HELOC might be priced at Prime plus 0.5%, meaning if the prime rate is 8.5%, the HELOC rate would be 9.0%. When the Federal Reserve raises or lowers the federal funds rate, HELOC rates adjust accordingly — often within a billing cycle. This variable-rate structure was particularly consequential for HELOC borrowers during the Fed's 2022-2023 rate hiking cycle, when the prime rate rose from 3.25% to 8.5%, dramatically increasing the cost of outstanding HELOC balances.
HELOCs are typically available up to a combined loan-to-value (CLTV) ratio of 80% to 90%, meaning the sum of the first mortgage balance and the HELOC line cannot exceed 80% to 90% of the home's appraised value. Most major banks, credit unions, and mortgage companies offer HELOCs, and the application process involves a home appraisal or automated valuation model assessment to establish current market value. HELOCs are recorded as second mortgages or junior liens against the property, subordinate to the first mortgage in the priority of claims in a foreclosure proceeding.
Popular uses of HELOCs include financing home renovations and improvements, funding college tuition, consolidating higher-interest debt, covering major unexpected expenses, or serving as a liquid emergency reserve for self-employed individuals or business owners with variable income. From a tax perspective, interest on a HELOC is deductible for borrowers who itemize deductions only when the proceeds are used to buy, build, or substantially improve the secured residence, consistent with the home mortgage interest deduction rules established by the Tax Cuts and Jobs Act of 2017 and enforced under IRS guidance.
Borrowers should be aware of the reset risk associated with HELOC repayment. If a large balance is outstanding at the end of the draw period and the borrower has been making interest-only payments, transitioning to fully amortizing payments over the repayment period can cause a significant jump in the required monthly payment. Lenders and regulators have paid increasing attention to this payment shock risk since the 2008-2012 housing crisis, when many borrowers with large HELOC balances experienced severe financial stress at the end of their draw periods.