The HELOC Guide: How a Home Equity Line of Credit Works

A Home Equity Line of Credit (HELOC) is not a standard loan; it is a revolving credit line. Imagine a credit card with a very high limit, a much lower interest rate, and your house as collateral. It is the ultimate tool for flexibility, but it requires discipline to manage correctly.

Two Phases of a HELOC

Unlike a standard loan, a HELOC has a lifecycle divided into two distinct periods:

The Draw Period (Typically 10 Years):

During this time, you can borrow money, pay it back, and borrow it again, up to your credit limit. Most lenders only require you to make "Interest-Only" payments during this phase. This keeps payments incredibly low, but it means you aren't paying down any actual debt.

The Repayment Period (Typically 10-20 Years):

Once the draw period ends, the line of credit freezes. You can no longer borrow. You must now pay back both the principal and interest. This can cause "Payment Shock," where your monthly bill suddenly doubles or triples overnight.

The Variable Rate Risk

HELOC rates are almost always variable, tied to the "Prime Rate." If the Federal Reserve raises rates, your HELOC payment goes up immediately.

Example: You borrow $50,000. If the rate is 5%, your interest-only payment is roughly $208. If rates jump to 9%, that same payment becomes $375—without reducing your balance by a penny.

Best Uses for a HELOC

HELOCs are ideal for expenses that are ongoing or uncertain in amount:

• Phased Home Improvements: You are doing a project in stages over two years and don't want to pay interest on the full amount until you actually use it.
• Emergency Fund: Some homeowners open a HELOC with a $0 balance just to have it available as a safety net for medical emergencies or job loss.
• Education Expenses: Paying tuition semester by semester.

Disclaimer: This guide is for educational purposes only and does not constitute financial advice.