HELOC

A HELOC is a credit card whose collateral is your house. The lender appraises the home, subtracts the mortgage balance from a share of its value, commonly 80% to 85%, and opens a line up to the difference; you draw on it when you need to, pay interest only on what you have drawn, and the rate is usually variable. The limit is not a debt: only the drawn balance is owed, and a line that is never used costs nothing but its fees. The house is the security, which is why the rate is far below a card's and why a missed payment carries a heavier consequence.

In a sentence

• "We opened a HELOC for $50,000 and drew $12,000 of it for the roof, so the interest-only payment is $85 a month."
• "The HELOC rate is variable, so the payment moved with the prime rate twice this year."
• "A HELOC is a line you draw on as you need it; a home equity loan hands you the whole amount at once at a fixed rate."

How it works

1. The lender sets the limit from the equity. It appraises the home, takes its cap on total borrowing against it, and subtracts the mortgage balance. Credit and income are checked as for any loan.
2. The draw period, commonly ten years, opens the line. You borrow any amount up to the limit, repay it, and borrow again, with a minimum payment that is often interest only on the drawn balance. The rate is an index plus a margin, so it moves with the index.
3. The repayment period, commonly ten to twenty years, closes the line. No new draws, and the payment becomes principal and interest that clears the balance by the end.
4. The lender holds a second lien behind the mortgage. If payments stop, the home can be foreclosed on, and the agreement lets the lender freeze or reduce the line if the home's value falls or your finances change.

Credit line = home value × the lender's cap − mortgage balance

An example

A home worth $420,000 with $286,000 left on the mortgage, at a lender that caps total borrowing at 80% of value; the cap and the 8.5% rate are the example's inputs.

The household owes $12,000, not $50,000, and the interest-only payment moves with the rate, to $95 a month if it rises to 9.5%. Opening the line and drawing the money into checking changed nothing on the net worth sheet; paying the roofer is when net worth fell by $12,000, and the balance stays a liability until it is repaid. At $300 a month instead of the minimum, the $12,000 is gone in 48 months with $2,160 in interest; the same $12,000 on a credit card at 24% takes 82 months at $300 and costs $12,383.

Why it matters

A HELOC is the cheapest large sum most homeowners can borrow, and the most dangerous to treat casually. Against a card, the rate is a fraction and the interest on the example's $12,000 is about a sixth; against a personal loan, it is usually cheaper, and there is no need to borrow the whole amount at once. The risks are the ones the structure creates. The rate is variable, so the payment rises when rates do; the minimum is often interest only, so a balance can sit for a decade without shrinking; the payment jumps when the draw period ends; and the debt is secured by the house, so moving card balances onto a HELOC turns unsecured debt into debt that can cost a home. The decision it belongs to is what the money is for: a roof or a kitchen that keeps the house whole, or spending that a line makes painless.

HELOC versus a home equity loan

A HELOC is a revolving line; a home equity loan is an installment loan. Both are secured by the same equity and sit behind the mortgage as a second lien, and the difference is how the money arrives and how the payment behaves. A home equity loan pays out the full amount at closing at a fixed rate, with the same payment every month until it is gone, which suits a single known cost. A HELOC opens a limit that is drawn as needed at a variable rate, with a payment that depends on the balance and the index, which suits costs that arrive over time or are not yet known. Both are secured loans; only the HELOC is revolving credit.

Common questions

Is a HELOC a second mortgage? Yes, in the sense that it is a lien on the home behind the first mortgage. In everyday use, second mortgage more often means a home equity loan, the lump-sum version.

Does a HELOC count against net worth? Only the drawn balance does, as a liability at its current amount. The unused part of the line is a limit, not a debt, and the home stays on the asset side at its estimate regardless of the line against it. See Home equity.

What happens when the draw period ends? The line closes to new borrowing and the payment becomes principal and interest on whatever is owed, spread over the repayment period. A balance carried at interest only for ten years can see its payment rise sharply at that point; some lenders will renew the line or refinance it, and a balance paid down during the draw period avoids the jump.

Is a HELOC a good way to pay off credit cards? It is cheaper, and it is riskier. The rate is far lower and the interest saving is real, but the card balances become debt secured by the house, and the cards are empty again. It works for a household that has already stopped adding to the cards, and it adds a second layer of debt for one that has not.

Go deeper

• How to count a 401(k) loan, a HELOC, or a car lease in net worth records the drawn balance rather than the limit and shows the worked sheet.
• The Mortgage calculator estimates the full monthly payment on a home and the total interest over the life of the loan, the first lien the HELOC sits behind.
• Does a house count toward net worth? values the home the line is secured by and explains which side of the sheet moves each month.

Where it shows up in Zypper

Zypper counts the HELOC at what is drawn and the house at what it is worth. A HELOC that connects as a loan contributes its drawn balance to the liability side of net worth; one that does not connect is a manual account at that figure, with its balance set by you and updated as you draw and repay. The house is a separate manual account at your estimate, and net worth is computed from every account, assets minus liabilities, and charted over time, so the line's balance shows against the home's value and the mortgage balance. See Net worth tracking and Manual accounts for the details, or get started with Zypper to keep the line on the right side of the sheet.