Is Taking Out a HELOC Right for You?

If you have at least 20% equity in your home and a credit score of 620 or higher, you may qualify for a home equity line of credit (HELOC). A HELOC is a convenient and often inexpensive way to borrow money using your home as collateral. Let's look at how a HELOC works and whether its features could make it a good (or bad) option for you.

Key Takeaways

A home equity line of credit (HELOC) works much like a credit card, allowing you to borrow and repay money as needed.
Compared with a credit card, a HELOC's interest rate can be significantly lower, and the loan has a defined term that requires you to repay everything you've borrowed by a certain date.
Your home serves as collateral for a HELOC, so if you can't repay what you've borrowed, you could lose it in foreclosure.

How Much Can You Borrow with a HELOC?

The first step in deciding if a HELOC is right for you is knowing whether you have enough home equity to qualify and, if so, how large a credit line you might be eligible for.

Your home equity is the difference between your home's appraised value and your mortgage balance (assuming you have an existing mortgage). For example, if your home is worth $500,000 and you owe $250,000, your equity is 50%. If your home is worth $500,000 and you don't have a mortgage, your equity is 100%.

To see whether you'd qualify for a HELOC, start by calculating your combined loan-to-value ratio (CLTV ratio), which takes into account both your current mortgage balance plus the home equity debt you hope to take out.

So, for example, if your home is valued at $500,000, your mortgage balance is $250,000, and you want a $50,000 HELOC, your CLTV would be 60% ($300,000 ÷ $500,000). So far, so good: Most lenders like to see a CLTV of 85% or less.

If you want to determine the maximum you might borrow, multiply your home's value ($500,000) by the lender's preferred maximum CLTV (let's say 85%). That's $500,000 x 0.85 = $425,000. Then, subtract the amount you owe on your existing mortgage ($250,000). So, $425,000 - $250,000 = $175,000. This is how much you could potentially borrow without exceeding the 85% CLTV limit.

Under the Fair Housing Act, mortgage lending discrimination is illegal. If you think that you've been discriminated against based on "race, color, religion, sex (including gender, gender identity, sexual orientation, and sexual harassment), familial status, national origin, or disability," there are steps you can take. One such step is to file a report with the Consumer Financial Protection Bureau (CPFB) or the U.S. Department of Housing and Urban Development (HUD).

How a HELOC Works

A HELOC is sort of like a credit card and sort of like a home equity loan. As with the former, it gives you a revolving line of credit and typically has a variable interest rate. As with the latter, it has a fixed term and a defined repayment period.

With a credit card, the bank gives you a credit limit based on your household income and credit score. You can spend as much or as little as you want in each billing cycle, as long as you stay under that limit. When you get your statement, you have to make at least the minimum monthly payment, but you can also repay the entire balance if you don't want to accrue interest. After the bank processes your payment, your available credit increases by the amount of your payment that went toward the principal balance.

A HELOC functions similarly, but here your credit limit is also based on how much equity you have in your home. Additionally, a HELOC has two periods:

First, there's a draw period, typically 10 years, during which you can borrow up to your credit limit and make interest-only payments.
Second, there's a repayment period, generally 20 additional years, when you can no longer borrow money but must repay your outstanding balance with interest.

What You Need to Qualify for a HELOC

In addition to sufficient home equity, a lender will want to know that you have enough income to make the payments on your HELOC.

So you'll need to document your income as you would if you were applying for any other type of mortgage: with pay stubs, W-2 forms, and income tax returns. By comparison, banks tend to take you at your word when you state your income on a credit card application.

Lenders decide whether you have enough income to qualify for a HELOC by looking at your debt-to-income (DTI) ratio, which compares your total monthly debt payments to your monthly gross income. Home equity lenders generally prefer to see a DTI ratio no higher than 43%, meaning that your monthly mortgage, student loan, auto loan, credit card, and proposed home equity loan payments combined should not exceed 43% of your pretax income. Some lenders will go higher, although it's worth remembering that the higher the DTI, the greater the debt burden you'll be taking on.

The Dangers of Using Your Home as Collateral

Because a HELOC is secured by your home, you could face foreclosure if you don't repay it.

Most credit cards and personal loans, by contrast, are unsecured. With unsecured debt, you're significantly less likely to lose your home if you can't repay what you borrow. Your creditors could still sue you for nonpayment and possibly win a judgment against you, but your home may be fully or partially protected if your state has a homestead exemption.

Variable vs. Fixed Interest Rates

Most HELOCs, like most credit cards, have variable interest rates that can rise or fall over time as economic conditions change. When you consider a HELOC offer, you'll want to know the lowest and highest rate you might be subject to and how often the rate will adjust.

If interest rates increase, will you still be able to afford the monthly payments? A HELOC is more manageable if you keep your borrowing well below your means and have enough flexibility in your budget to deal with fluctuating payments.

If you want to combine the stability of a home equity loan with the flexibility of a HELOC, you can also shop around for a HELOC with a fixed-rate option.

Can I Get a Tax Deduction on Home Equity Line of Credit (HELOC) Interest?

Unlike the interest on a credit card, a home equity line of credit's interest can sometimes be tax deductible up to certain limits. But that's only if the loan is "used to buy, build or substantially improve the taxpayer's home that secures the loan," according to the Internal Revenue Service (IRS).

This restriction became law in 2018 and applies through the 2025 tax year. Unless Congress extends it, as of 2026, home equity loan and HELOC interest will be eligible for a deduction regardless of how you use the loan proceeds.

Note that to claim the deduction you will need to itemize your deductions when you file your taxes rather than taking the standard deduction.

Should I Refinance My High-Interest Debt With a HELOC?

That can sometimes be a good idea. Let's say the annual interest rate on a HELOC is 10% and the interest payments are tax deductible, while the annual interest rate on your credit card debt is 25% and the interest payments are definitely not tax deductible. In this scenario, or even one where the HELOC's rate goes up by 5% or 10%, you could potentially save a ton of money and get out of debt faster by using a HELOC to pay off your credit card balances. In effect, you will have swapped a high-interest loan for a low-interest loan.

However, some people will use a HELOC or a home equity loan to pay off high-interest debt and then use their newly replenished credit card limits to accumulate even more of it. This is a practice known as reloading, and it often doesn't end well.

It's also worth remembering that a HELOC puts your home at risk, unlike a credit card.

Do I Have to Get My HELOC From the Company That Services My Mortgage?

You may receive offers to apply for a HELOC from your mortgage lender or loan servicer, but you're free to get a HELOC from any lender you wish. Those offers don't mean that you're approved, and you shouldn't assume that you'll get the lowest interest rate available. Instead, it's smart to shop around for the best HELOC to find the least expensive option.

The Bottom Line

If you want to borrow against your home using a HELOC, make sure that you understand how it works first. In particular, you'll want to know when your interest rate might change and by how much.

If you're looking to use a HELOC to pay off existing debts, you may want to consider some other strategies, such as the debt snowball or debt avalanche methods. You could also refinance your debts with another loan that's not secured by your home, such as a personal loan, or by transferring your credit card debt to a card with a low- or 0%-interest introductory period.