How Does a Home Equity Line of Credit (HELOC) Work?

Please note: Discover Home Loans offers a home equity loan product, but does not offer HELOCs.

A home equity line of credit (HELOC) allows you to borrow money using the equity you’ve built in your home. It gives you access to a revolving line of credit that lets you borrow what you need when you need it up to a set limit.

While Discover® does not provide HELOCs, we can help you tap into your equity with a home equity loan. While both a HELOC and home equity loan use your home as collateral, there are key differences between the two. A HELOC works like a credit card and has a variable interest rate and variable monthly payments. A home equity loan is usually a lump sum payment with a fixed interest rate, fixed term, and fixed monthly payments.

Wondering whether a HELOC or home equity loan is right for you? Let’s look at how HELOCs work, as well as how they differ from home equity loans.

Your HELOC works as a line of credit

If you’re approved for a HELOC, you’ll receive a line of credit with a limit determined by how much equity you have in your home. A HELOC has two main phases.

The first phase is the draw period. The draw period typically lasts five to ten years. During this time, you can borrow money from your line of credit and make smaller payments. Your minimum monthly payments are based on your interest rate, and you only pay interest on the amount you borrow, not the full amount available.

Once the draw period ends, some lenders offer the option to renew your line of credit. If you don’t renew or, if you don’t have the option to renew, you enter the repayment period.

Once you enter the repayment period, you can no longer withdraw funds from your credit line, and you start paying back the balance of your loan. This involves monthly payments to the principal and interest. You only pay back the amount you withdrew, so, if you took out a HELOC for $60,000 and you only used $35,000, then you only pay back the $35,000 plus interest.

Some HELOCs don’t require consistent monthly payments. Instead, they’re structured with a balloon payment where the entire balance (principal and interest) is due at the end of the draw period. Other HELOCs allow you to convert to a traditional ten, fifteen, or twenty-year loan.

How does a HELOC work vs. home equity loans?

While a HELOC allows you to borrow and pay back as needed, a home equity loan functions more like a traditional loan. With a home equity loan, you receive a lump sum that has a fixed interest rate and fixed monthly payments. The advantage of a home equity loan is that you know exactly what your monthly payments will be so you can budget accordingly. On the other hand, a HELOC typically has a variable interest rate, so your payments will vary from month to month.

You generally don’t have to start repaying a HELOC until the repayment period starts; you may only need to repay the interest on the funds you use. With a home equity loan, you start repaying the principal and interest with fixed monthly payments as soon as you receive the loan. 

A HELOC typically has a draw period of five to ten years followed by a repayment period of about 20 years, on average. How much you can borrow depends how much home equity you have. While Discover does not offer HELOCs, most lenders allow you to borrow up to 90% of your combined loan to value ratio (CLTV).

A home equity loan typically offers repayment terms ranging from five to thirty years. The loan’s length dictates how high your monthly payments are. Generally, the longer your term, the lower your monthly payment, but the more interest you pay overall. Discover offers ten-, fifteen-, twenty-, and thirty-year home equity loans ranging from $35,000 to $300,000. Your CLTV ratio must be less than 90%.

Steps in the HELOC process

Applying for a HELOC involves several steps, including:

Check your credit score

Your credit score is a key factor for lenders. You still may be able to qualify with a lower credit score, however, you will likely pay a higher interest rate. You can always check the lender’s specific credit score requirements to see if you meet the criteria. Taking the time to improve your credit score can help increase your chances of being approved.

Apply for a HELOC

Most lenders allow you to apply for a HELOC online or over the phone. Some lenders also offer in-person applications. You will need to provide demographic and income information. Having all your information available and ready to go can make your application process go smoothly.

The home appraisal process

To calculate your home equity, lenders need to know its market value. The lender will typically set up an appraisal and must let you know how much it will cost. Sometimes, as in the case with Discover, an automated valuation model (AVM) is used at no cost to you.

Closing a HELOC

Once your home is appraised, your lender will let you know whether you are approved for a HELOC. They will also disclose your credit limit amount and other details of your terms, including your interest rate and repayment schedule. If these terms work for you, you can move forward and close on your HELOC.

Begin using your HELOC

After you sign your loan papers, you have three business days (including Saturdays) to cancel. You can cancel for any reason. If you decide you want to move forward, you can access your funds after three business days. Many lenders permit online bank transfers or a HELOC account card similar to a debit card. Speak with your lender to discuss the best ways to access your HELOC.

Interest-only draw periods

During the draw period, you can withdraw funds from your line of credit whenever you need them. Many borrowers only pay back the interest on the amount they’ve borrowed during this time but, you can also pay back the principal. Be aware that some lenders have a minimum draw requirement based on your total line of credit.

Repayment periods

After the draw period you enter the repayment period. You can no longer draw funds from your HELOC and you begin repaying the balance, with interest. The length of the repayment period depends on your HELOC’s structure, and the amount you owe depends on how much you borrowed during the draw period.

Can I sell my house if I have a HELOC?

Yes, it is possible to sell your house if you have a HELOC. However, you will have to repay the remaining balance of your HELOC as well as your primary mortgage using the money from the sale. This can work out if your home has appreciated enough to cover your mortgage and remaining HELOC balance. However, if you can’t cover the entire amount, you need to find a way to pay off the balance of your HELOC before you can close on your home.