What Is a HELOC and How Does It Work?

Home equity is the difference between your home’s current value and what you still owe on your mortgage.

For example, if your home is worth $500,000 and you owe $300,000 on your mortgage, you have approximately $200,000 in equity. As you pay down your mortgage—or your home increases in value—your equity may grow.

That equity can potentially provide borrowing power through a HELOC.

A HELOC is a revolving line of credit secured by your home. It works somewhat like a credit card: you receive an approved credit limit and can borrow what you need, when you need it, during the draw period.

Unlike a traditional loan that provides all the money upfront, a HELOC gives you flexibility to borrow over time. That can be particularly useful for projects with costs that occur in stages, such as a home renovation.

You pay interest only on the amount you actually borrow, rather than your entire available credit line.

Flexibility - one of the biggest advantages of a HELOC is having access to funds when you need them.
If you're remodeling your kitchen, for example, you may have contractor payments, materials and unexpected expenses spread over several months. Rather than borrowing one large lump sum at the beginning, a HELOC lets you draw funds as expenses arise.

Potentially Lower Interest Rates - because a HELOC is secured by your home, interest rates are often lower than rates on unsecured borrowing options such as personal loans or credit cards.

Keep in mind that HELOC rates are generally variable, which means your rate—and potentially your payment—can change over time.

Borrow for More Than Home Improvements - home renovations are a common use for HELOCs, but they aren't the only one. Depending on your needs, home equity may be used for major repairs, education expenses, debt consolidation or other significant expenses.

Whatever the purpose, it’s important to borrow carefully and have a clear plan for repayment.

A HELOC generally has two phases: a draw period and a repayment period.

During the draw period, you can borrow from your available credit line as needed, up to your approved limit. Depending on the terms of the HELOC, payments during this period may primarily consist of interest on the amount you've borrowed.

 

When the draw period ends, you enter the repayment period. You can no longer make additional draws and begin repaying the outstanding principal plus interest according to the terms of your loan.

Your available credit will depend on several factors, including your home equity, existing mortgage balance, credit history and income.   

Having an available line of credit doesn't mean you need to use all of it. A few simple habits can help keep borrowing manageable:

• Start with a budget. Know what your project or expense is likely to cost before borrowing.
• Borrow only what you need. Every dollar borrowed will eventually need to be repaid with interest.
• Plan for changing rates. Because HELOC rates are typically variable, consider whether your budget could handle a higher payment.
• Understand the terms. Know your draw period, repayment period, rate and any applicable fees before you borrow.

A HELOC is secured by your home. That can help provide favorable borrowing terms, but it also means your home serves as collateral. Failure to repay the loan according to its terms could result in foreclosure.

Variable interest rates are another consideration. If rates rise, the cost of borrowing may increase.

Before opening a HELOC, consider both the benefits and the risks and make sure the payments comfortably fit your budget. 

Both options allow you to borrow against your home's equity, but they work differently.

A HELOC provides a revolving line of credit that you can access as needed and typically has a variable interest rate.
A home equity loan generally provides the money in one lump sum and may offer a fixed interest rate and predictable monthly payments.

The right choice depends on how much you need, when you need it and whether you prefer flexibility or predictable payments.

A HELOC can be a useful way to put the equity you've built in your home to work—but it should fit comfortably within your overall financial picture.

At NESC Credit Union, we're here to help you understand your options, ask questions and decide what works for you.