A home equity line of credit, or HELOC, lets a homeowner borrow against the part of the home they already own. The Consumer Financial Protection Bureau (CFPB) describes it as "a loan that allows you to borrow, spend, and repay as you go, using your home as collateral." Equity, in the CFPB's words, is "the value of your home minus the amount you owe on your mortgage."
That flexibility is the appeal. The collateral is the risk. The CFPB's HELOC booklet, which lenders must give applicants under federal law, says it plainly: "If you fall behind or can't repay the loan on schedule, you could lose your home."
This guide walks through five things the CFPB, the Federal Reserve and the Federal Trade Commission (FTC) highlight for people thinking about a HELOC. It is educational, not advice, and Spectre does not offer HELOCs.
1. Know how the rate moves and where it stops
The CFPB says HELOCs "usually have a variable interest rate, so your payments may change from month to month." A variable rate usually has two parts:
- The index, which the CFPB calls "a measure of interest rates generally that reflects trends in the overall economy." It lists the U.S. prime rate and the Constant Maturity Treasury (CMT) rate as common examples.
- The margin, "an extra percentage that the lender adds to the index."
Federal rules limit how the rate can change. Under Regulation Z, a lender may change a HELOC's rate only if the change is "based on an index that is not under the creditor's control" and that index "is available to the general public."
There is also a ceiling. Regulation Z requires dwelling-secured credit contracts whose rate can rise to state "the maximum interest rate that may be imposed during the term of the obligation." This is often called a lifetime cap. Lenders must also disclose "any annual or more frequent periodic limitations on changes in the annual percentage rate." Those are periodic caps, if the plan has them. The CFPB's comparison worksheet lists the "interest rate cap and floor" and the "frequency of rate adjustments" as items to compare across offers.
Two more details can catch people out. The CFPB notes that some lenders offer an "introductory or teaser rate that is unusually low for a short period, such as six months." And on a variable-rate plan, "your monthly payments may change even if you don't draw more money."
2. Count every fee, not just the rate
The CFPB says some lenders waive some or all up-front costs, while others may charge:
- A property appraisal fee.
- An application fee, "which might not be refunded if you are turned down."
- Closing costs, including "fees for attorneys, title search, mortgage preparation and filing, property and title insurance, and taxes."
Costs don't stop at closing. The CFPB's worksheet for comparing three offers also lists points, early termination fees, annual fees, transaction fees, inactivity fees, and prepayment and other penalty fees. The FTC notes that lenders must disclose "the creditor's charges to open, use, or maintain the account," such as "an application fee, annual fee, or transaction fee."
The CFPB adds a tip about timing. If you sell your home, "you are generally required to pay off your HELOC in full immediately." For someone who may sell soon, the up-front costs of opening a line are worth weighing.
Federal rules also give a short window to change your mind. The CFPB explains that under federal law a borrower can cancel the credit line within the first three days by notifying the lender in writing. The lender must then return the fees paid, including application and appraisal fees. The FTC says this right applies "if you're using your main residence as collateral."
3. Treat the draw period as a borrowing plan, not a balance
During the draw period, the CFPB says, a borrower "can generally spend up to your credit limit anytime." It gives 10 years as an example of how long that period might last. Some plans require minimum draws or a minimum balance.
An open line that refills as you repay can make it easy to borrow more than planned. The CFPB booklet closes with three questions:
- "Have I considered other sources of money and loans, besides a HELOC?"
- "Have I shopped around for HELOC features and fees?"
- "Am I comfortable with the worst-case scenario, where I could lose my home?"
A line of credit that refills itself still has to be repaid, and the house stands behind every dollar of it.
4. Understand what your payments actually pay off
Payments made during the draw period may not be shrinking the debt much. The CFPB explains that some plans set a minimum payment that includes some principal plus interest, but "the portion of your payment that goes toward principal typically does not repay the principal by the end of the term." Other plans allow interest-only payments, "which means that you pay nothing toward the principal."
When the draw period ends, the repayment period begins. The CFPB says the lender may set a schedule to repay the full amount, "often over ten or 15 years." Or the borrower may owe the whole balance at once, a balloon payment. The FTC says such a payment "is often large because it includes the unpaid principal balance and any remaining interest due." The CFPB warns that if a borrower can't make a balloon payment in full, "you could lose your home."
This is why many people pay principal early. Paying principal during the draw period means a smaller balance when repayment starts. The CFPB's worksheet suggests checking whether an offer has a "penalty for overpayments," prepayment fees or an early termination fee, because these affect what paying early really costs.
5. Know what happens if your home's value falls
A HELOC's credit limit isn't guaranteed for the life of the plan. The CFPB says HELOCs "generally permit the lender to freeze or reduce your credit line if the value of your home falls or if they see a change for the worse in your financial situation." Regulation Z lets a lender reduce the limit or stop further draws "during any period in which property value declines significantly below the property's value at plan opening."
The Federal Reserve's tips for handling a freeze or reduction explain what happens next:
- The lender must send written notice "no later than 3 business days after the freeze or reduction," and the notice should give specific reasons.
- The lender "must reinstate your credit privileges when the conditions permitting the freeze or reduction no longer exist." A written request may be needed.
- The lender may charge for an appraisal and credit report when it reviews a reinstatement request. It cannot charge a fee to reinstate the line once the condition has gone away.
The CFPB also suggests asking the lender why it acted, checking credit reports for errors, and, where relevant, asking about a new appraisal.
Where to read more
The CFPB's booklet What you should know about home equity lines of credit is short and includes a worksheet for comparing three offers side by side. The CFPB says lenders must also give applicants a list of HUD-approved housing counselors, who can explain how HELOCs work and offer free or low-cost budgeting help.