HELOC: How a Home Equity Line of Credit Works

Draw period and repayment period

During the draw period you can borrow, repay and borrow again, and most lenders require only interest payments. That flexibility is the product's real advantage: for a renovation of uncertain cost or an irregular funding need, you pay only for what you actually use.

At the end of the draw period the line converts. Payments jump because principal is now included over a compressed term, and borrowers who treated interest-only payments as the real cost of the loan get a shock. Model the repayment-period payment before you draw anything.

Why the rate moves

Almost all HELOCs are variable, priced as the prime rate plus a margin set by your credit profile and loan-to-value ratio. When prime moves, your payment moves with it, usually within a billing cycle or two.

Check the lifetime cap and any periodic cap in the agreement, and ask whether the lender offers a fixed-rate conversion option on part of the balance. Stress-test the payment at two or three percentage points above today's rate before committing.

Costs and terms to check

HELOC pricing is not just the rate. Several contract terms decide the real cost.

• Annual fee, and whether it is waived with a minimum balance.
• Early closure fee if you close the line within the first two or three years.
• Minimum draw at closing, which forces you to borrow immediately.
• Introductory teaser rate and the length of the promotional period.
• Whether the lender can freeze or reduce the line if home values fall.

Who a HELOC suits

It fits homeowners with substantial equity and a variable or staged funding need: a phased renovation, tuition paid semester by semester, or a standby liquidity buffer for a self-employed household.

It fits badly where the need is a single fixed amount — a home equity loan gives a fixed rate and payment for that — and where the borrower's income could not absorb a rate rise. Never use a HELOC as an extension of everyday spending; the collateral is your house.