How a HELOC Works — the straight facts

A HELOC is similar to a credit card backed by your home. A lender approves a maximum borrowing limit based on your home’s value, your existing mortgage balance, credit score, and debt-to-income ratio. During the “draw period” (commonly 5–10 years) you can borrow, repay, and re-borrow up to the limit. Many HELOCs offer interest-only payments during the draw period. After the draw period ends, the loan enters the repayment period, when principal plus interest must be repaid according to the lender’s schedule.

Key terms to know:

  • Loan-to-value (LTV): The percentage of your home’s value the lender will consider when setting your limit (often up to 80–85% combined LTV with existing mortgages).
  • Draw period: Time when you can access funds.
  • Repayment period: Time when principal repayment begins and the line typically closes to new draws.
  • Variable rate: Most HELOCs use an index plus a margin; your interest can move up or down with market rates.

Sources: Consumer Financial Protection Bureau (CFPB) overview on HELOCs and lender disclosures (https://www.consumerfinance.gov/).

Typical uses and potential benefits

  • Home improvements that increase property value. Investing in a kitchen, roof, or energy upgrades can offer a measurable return in resale value.
  • Debt consolidation. High-interest credit card balances can sometimes be reduced using a lower-rate HELOC, but this moves unsecured debt to secured debt—your home becomes collateral.
  • Short-term cash needs. A HELOC’s flexibility is useful for emergencies or timing large expenses.
  • Bridge financing. Use HELOC funds temporarily while selling one home and buying another.

In my financial-advisory practice, clients who used HELOCs for strategic, value-adding projects (major renovations with a realistic budget and timeline) typically saw better outcomes than those who used HELOCs for discretionary spending.

Risks and downsides you must consider

  • Your home is collateral. Defaulting can lead to foreclosure.
  • Variable interest rates. Rising rates increase your monthly payment and total interest cost.
  • Payment shock after the draw period. Moving from interest-only to fully amortizing payments can sharply raise monthly obligations.
  • Fees and closing costs. Not all HELOCs are cheap once origination fees, appraisal costs, annual fees, and early termination penalties are included. See our deep dive on hidden HELOC costs: Hidden Costs in HELOCs: What Borrowers Miss.
  • Over-borrowing. Treating a HELOC like a second credit card can erode equity and leave homeowners under-secured.

How payments and interest typically work — a short example

Imagine a $200,000 home with a $120,000 mortgage balance. The lender allows a combined LTV of 85%: 0.85 * $200,000 = $170,000 maximum combined debt. The HELOC limit would be $50,000 (=$170,000 – $120,000).

If you draw $30,000 and your HELOC rate is 6% during a 10-year draw period that allows interest-only payments, your monthly interest-only payment on the $30,000 would be about $150. If, after the draw period, the HELOC converts to a 15-year amortization at a higher rate, your monthly payment will include principal and could increase substantially. Plan for this “repayment shock.” This example is illustrative; actual rates, terms, and taxes vary.

Taxes: When is HELOC interest deductible?

Under current IRS rules (as of 2025), interest on a HELOC is deductible only if the funds are used to buy, build, or substantially improve the home that secures the loan. Interest used for other purposes (e.g., personal expenses or paying off unsecured debt) is generally not deductible. Also, total mortgage interest deduction limits apply to acquisition indebtedness and combined mortgage balances (see IRS Publication 936 for full details). Always check the latest IRS guidance or consult a tax advisor for your situation (IRS: https://www.irs.gov/).

Qualifying for a HELOC: what lenders look for

  • Sufficient equity, typically at least 15–20% remaining after the new combined LTV calculation.
  • A credit score that meets the lender’s minimum (many lenders look for scores 620+; better rates require higher scores).
  • Stable income and reasonable debt-to-income (DTI) ratios.
  • Clean payment history on existing mortgages and major debts.

If you aren’t sure whether you qualify, lenders provide prequalification tools, and you can check your likely limit and rate offers without harming your credit in many cases.

How to decide whether a HELOC is right for you — a practical checklist

  1. Define the purpose: Is the HELOC funding a value-adding improvement, consolidating high-rate debt, or covering a true emergency? Priority should go to uses that either reduce interest expense or increase home value.
  2. Budget for repayment: Model payments if rates rise 2–4 percentage points and for the repayment phase after the draw period.
  3. Compare alternatives: fixed-rate home equity loans, cash-out refinance, or a personal loan might be better fits depending on rates and loan terms. See related comparison: Home Equity Loan vs HELOC: Uses and Risks.
  4. Understand fees and clauses: ask about origination fees, annual fees, appraisal costs, and whether the lender can freeze or reduce your limit.
  5. Keep an emergency buffer: avoid borrowing your entire available limit.

Common borrower mistakes and how to avoid them

  • Treating a HELOC like a credit card: set a strict draw plan and repayment schedule.
  • Ignoring variable-rate risk: consider converting part or all of a variable HELOC balance to a fixed-rate option if your lender offers one.
  • Overlooking closing costs and fees: read the fee disclosures and include them in your cost comparison.
  • Using a HELOC for non-home-related discretionary spending: if the interest isn’t tax-deductible and you risk your home, weigh alternatives.

More on specific HELOC terms, draw-period math, and how variable interest is calculated can be found in our guide: HELOC Draw Periods and Interest Calculations: What Borrowers Should Know.

Alternatives to consider

  • Home equity loan (fixed-rate lump sum) — good for one-time, known-cost projects.
  • Cash-out refinance — can replace your first mortgage and convert equity into cash at a fixed rate; can be efficient if first-mortgage rates are low.
  • Unsecured personal loan — avoids using your home as collateral but typically has a higher rate.
  • Credit cards for small projects — only for small, short-term costs you can pay off quickly.

If you need help choosing between options, our guide comparing HELOCs with personal loans for repairs may help: HELOC vs Personal Loan for Home Repairs: Decision Guide.

Practical strategies for responsible HELOC use

  • Use a HELOC for projects with a clear budget and measurable expected return (e.g., energy-efficient upgrades, necessary repairs, structural improvements).
  • Plan to pay principal as soon as cash flow allows; paying only interest prolongs exposure to rate risk.
  • If you used a HELOC to pay down higher-rate debt, commit to a repayment plan that avoids re-accumulating unsecured debt.
  • Maintain an emergency fund so you don’t rely on your HELOC as primary liquidity.

In my experience advising clients, the homeowners who succeed with HELOCs pair the line with a written plan: stated purpose, target payoff timeline, and a contingency if interest rises.

Closing guidance and resources

A HELOC can be a flexible, cost-effective borrowing tool when used for the right purpose and with full awareness of its risks. Before you sign, compare offers, read all disclosures, and model payments both during the draw period and the repayment period. For consumer-focused guidance, see the Consumer Financial Protection Bureau’s HELOC resources (https://www.consumerfinance.gov/). For tax questions, consult IRS Publication 936 or a tax professional (https://www.irs.gov/).

Disclaimer: This article is educational and not personalized financial or tax advice. Consult a licensed financial advisor or tax professional before making borrowing decisions that affect your home.

Author note: As a senior financial editor who has advised clients on home-equity borrowing for more than a decade, I’ve seen HELOCs work well when used conservatively and fail when treated as an open invitation to borrow. Set explicit aims, model worst-case scenarios, and keep your home’s equity protected.