A home equity line of credit (HELOC) lets you use the equity in your home as collateral for a revolving credit line. While HELOCs can be helpful financial tools, there are also some common misconceptions about how they work. Let's clarify those so you can make a decision about when and whether applying for a HELOC is a good idea.
1. Myth: HELOC Approval Is Guaranteed
The equity you've established in your home will secure the HELOC, and equity is guaranteed to be a requirement. But lenders consider more than just your home equity when reviewing your application.
Fact: Qualifying for a HELOC Depends on Multiple Factors
As with other types of loans, lenders will consider various factors when reviewing your application and setting your credit line's rates and terms. For HELOCs in particular, lenders may require:
- Home equity: At most, lenders will generally offer you a HELOC with a credit limit that could bring your total mortgage balance to 60% to 85% of your home's current value. That includes the HELOC's credit limit plus your outstanding mortgage, which means you need to have at least 15% to 40% equity in your home.
- A good credit score score: Your credit score will also be an important factor, and you might need a score of 680 to 720—although a higher score could improve your chances and offers.
- Verified income and a low debt-to-income ratio: You'll likely need a stable and regular income to qualify, and lenders will also consider your other debt payments. Your resulting debt-to-income ratio (DTI) can help lenders determine whether you can afford to take on a new loan, and you might have trouble qualifying for a HELOC if your DTI is over 43%.
Requirements and specifics will vary by lender, and you may want to shop around to see which lenders will offer you a HELOC and the rates and terms of your offers.
2. Myth: You Need to Wait Years to Borrow a HELOC
Some lenders have waiting periods, but you don't necessarily need to wait years to qualify for a HELOC.
Fact: There Is No Set Waiting Period for a HELOC
Even if you find a lender that doesn't have a waiting period, there are a few reasons most people don't get a HELOC right away.
One is that they might not have a lot of equity in their home yet—it might take years for you to pay down your mortgage or for your home's value to increase enough for a HELOC to make sense. Additionally, if you're taking out a mortgage to buy the home, it might make sense to put less money down and use the cash rather than apply for a second loan. Or, use a mortgage that will also give you cash for repairs or improvements.
If you've made a large down payment or your home gets appraised for more than its purchase price, you might have enough equity to qualify for a HELOC from the start. There might be some situations when it does make sense to get a HELOC right away.
3. Myth: You Can't Deduct Interest Payments on a HELOC
The Tax Cuts and Jobs Act (TCJA) of 2017 introduced several changes to home equity interest, including the suspension of deductions for interest payments on home equity loans and HELOCs from 2018 to 2025. There are exceptions, however.
Fact: Interest Might Be Deductible Depending on How You Spend Loan Proceeds
You can still deduct the interest you pay on a HELOC, but only if you use your primary or second home to secure the HELOC and you use the money to buy, build or substantially improve your main home or second home. A substantial improvement includes improvements that add to your home's value or useful life, or that adapt your home to new uses.
For example, taking out a draw to pay for medical expenses or a vacation doesn't qualify, and even paying for necessary minor home repairs or maintenance might not qualify. However, when you take a draw to add a new bedroom, upgrade your kitchen or repair your roof, you might be able to deduct the related HELOC interest payments.
4. Myth: HELOCs and Home Equity Loans Are the Same
HELOCs and home equity loans (HELs) share some characteristics, but they're also very different in several important ways.
Fact: HELOCs and HELs Are Different Types of Loans
Although you'll use your home equity as collateral for both HELOCs and HELs, they're not the same.
A HELOC is a revolving line of credit, similar to a credit card, that you can borrow against. You'll only pay interest if and when you take out a loan (called a draw) against your credit line. You can take multiple draws depending on when you need to borrow money, and you may be able to make low, interest-only payments for a time.
A home equity loan is an installment loan, similar to a mortgage or a personal loan. You receive the entire loan amount upfront, it starts accruing interest right away, and you'll generally make interest and principal payments for the loan's predetermined repayment period.
There can be other important differences between HELOCs and HELs as well. For instance, HELOCs tend to have variable interest rates, and your interest rate and monthly payments could change as a result. With a HEL, you might lock in a fixed interest rate when you take out the loan. Learn more about both options if you're considering using your equity to borrow money.
5. Myth: You Always Need a Full Home Appraisal
Your eligibility for a HELOC and your HELOC's credit limit depend on how much equity you have. Your equity, in turn, depends on your home's current value and your outstanding mortgage balance. You don't always need to get or pay for a full appraisal.
Fact: HELOCs Often Require an Appraisal, but Not Necessarily a Full One
Lenders will generally require an appraisal before offering you a HELOC. And some lenders may require a full appraisal—the type where an appraiser does a full inspection of your home's interior and exterior and compares it to similar homes that recently sold in your area.
However, other lenders may be satisfied with a drive-by, desktop or automated valuation appraisal. These can determine your home's approximate value based on an exterior inspection, comparing similar home sales and your home's tax records. You might prefer these options, which could take less time and cost less money.
Lenders will determine the type of home appraisal required based on different factors. For example, if you recently had a home appraisal, the lender might not require a new one. Or, you might be able to get approved without a full appraisal if you're applying for a small HELOC or have good credit.
6. Myth: You'll Have to Pay Closing Costs out of Pocket
You might worry about the upfront cost of opening a HELOC, but you won't necessarily have any out-of-pocket costs.
Fact: HELOCs Don't Always Have Closing Costs
Closing costs for HELOCs can cover the expenses for an appraisal, credit check, title search and required government fees and taxes. Some lenders cover the HELOC's closing cost on the borrower's behalf, or split the costs with borrowers. If you use a lender that also doesn't charge application fees or annual fees, you might not have to pay anything to open or keep your HELOC.
When lenders do charge closing costs, the amounts can depend on the size of the credit line, application requirements and where you live. If you have to pay these costs, you also may be able to roll them into your HELOC rather than pay for them out of pocket when you close.
7. Myth: Your HELOC's Credit Limit Is Guaranteed
You might think that you can rely on your HELOC's credit limit as long as your account is open and in good standing. But that's not necessarily the case.
Fact: Lenders Can Freeze Your HELOC or Lower Its Credit Limit
Although lenders can't lower your account's credit limit below its current balance if doing so would increase your required payments, they can freeze your HELOC or reduce your credit limit in certain circumstances.
Lenders can freeze your HELOC—meaning you can't take any new draws—if the value of your home has seen a significant decline. In general, a decline of at least half of the equity you had after opening the HELOC might be considered significant.
For example, if you had a $250,000 home with a $180,000 mortgage and got a $20,000 HELOC, you'd have $50,000 of equity remaining. If your home value declines by $25,000, the lender might freeze your HELOC or lower your credit limit so that it's based on your home's new value.
A lender can also lower your HELOC's credit limit if it thinks you'll have trouble making payments.
Should You Get a HELOC?
HELOCs offer a flexible funding option and may have relatively low interest rates. Using a HELOC to pay for home improvements, consolidate high-interest debt or cover other necessary expenses might make sense. Now you also know that you don't necessarily need to wait to apply, get an appraisal or pay closing costs—you might even get a tax benefit.
However, HELOC amounts, rates and credit limits aren't guaranteed. The variable interest rate could also wind up being costly if interest rates increase, and you won't necessarily have access to your HELOC during an emergency if your lender freezes or reduces your account.
With all that in mind, you might want to explore your options. You can start by approximating your equity based on your home's current value. Also, you can check your Experian credit report and FICO® Score☉ for free, as your credit can be an important factor in your eligibility and offers.