What is a home equity line of credit?
A home equity line of credit, also known as a HELOC, is a revolving line of credit secured by your home. Homeowners often use home equity lines of credit for large expenses such as home improvements or debt consolidation. They may have lower interest rates than other loans, and the interest is usually tax-deductible.1
How a HELOC works
With a HELOC, you can borrow against the available equity in your home up to your credit limit. You can use your line of credit as often as you want throughout your borrowing period (or draw period), which is usually 10 years.
As you use your HELOC, you’ll receive a monthly bill for your minimum payment. Some lenders only require interest payments during the borrowing period. Others have you pay principal and interest, which may help keep your payments more consistent over time. The amount due may change based on your balance and interest rate fluctuations, or if you make additional principal payments. Making extra principal payments when possible helps you pay less interest and reduces your overall debt more quickly. Like with a credit card, as you repay your outstanding balance, the amount of available credit is replenished.
At the end of your borrowing period, you can no longer take out money and you must pay off what you owe, usually over a 20-year repayment period.
Tip: If you default on your HELOC, the lender could foreclose on your home, so it’s important to carefully consider what you’re borrowing for and make sure you have a plan to pay it off.
How to qualify for a HELOC
To qualify for a HELOC, you need to have enough available equity in your home. Typically, you can borrow up to 85 percent of your home’s appraised value minus any amounts you still owe on your mortgage or other loans secured by the home. Your lender also usually looks at your credit score and history, employment history, monthly income and monthly debts, just as when you first got your mortgage. A better credit score improves your chances of qualifying.
Tip: Ask your lender if you will be responsible for any fees associated with your HELOC, such as an application fee, an annual fee, closing costs and a cancellation or early closure fee.
What’s a variable interest rate?
When your HELOC has a variable interest rate, it can change from month to month. The variable rate is calculated using an index and a margin.
An index is a financial indicator banks use to set rates on many consumer loans. Most banks, including Bank of America, use The Wall Street Journal prime rate as the index for HELOCs. The index, and consequently your HELOC interest rate and required payment, can move up or down.
A margin is the number of percentage points added to the index, and it remains constant throughout the life of the line of credit. If the prime rate is 4 percent and you’re given a 2 percent margin, your interest rate will be 6 percent. If the prime rate drops to 3.5 percent, your interest rate will be 5.5 percent.
What’s a fixed-interest-rate option?
Some lenders, including Bank of America, allow borrowers to convert a portion of the outstanding variable-rate balance on a HELOC to a fixed rate. Payments are predictable and stable, and this option can protect you from rising interest rates. Fixed interest rates on a HELOC are typically higher than variable HELOC rates. Learn more about Bank of America’s Fixed-Rate Loan Option.
- Neither Bank of America nor any of its affiliates or financial advisors provide legal, tax or accounting advice. You should consult your legal and/or tax advisors before making any financial decisions.
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