Home equity loans and HELOCs, how each one works

Home equity is the value of your home minus what you owe on the mortgage. Two kinds of loan let you borrow against it. Both are common kinds of second mortgage, which is a loan that uses the house as collateral while another loan is still secured by it.

A home equity loan

A home equity loan pays the money as a lump sum. It usually has a fixed interest rate, one that won't change. These loans may have upfront fees and costs.

A HELOC

A home equity line of credit is an open-end line of credit that lets you borrow repeatedly against your equity. It runs in two periods.

• The draw period. You can generally spend up to your credit limit at any time, often with special checks or a card. It could last 10 years, for example. Some plans require a minimum amount each time you borrow, or a minimum balance kept outstanding.
• The repayment period. You can no longer borrow, and the lender may set a schedule to repay the full balance, often over 10 or 20 years. Monthly payments are often significantly higher once repayment starts. In some cases, the whole amount borrowed is due as soon as it begins.

HELOCs usually have a variable rate, so payments may change from month to month. Some let you convert part or all of the balance to a fixed rate, which is usually higher but more predictable.

When the line can shrink

If the home's value drops significantly, the lender might stop further borrowing on the line. It might also freeze the line if your finances change and it doesn't believe you can make the payments.

The risk both carry

Both loans use the house as collateral, so if you can't repay a home equity loan or a HELOC, you could lose your home. When a home is sold to pay its debts, a second mortgage is paid off after the first, so it often carries a higher rate than a first mortgage.

An annotated example

What to do next

If you have a home equity loan or a HELOC, file its terms with your mortgage papers. For a HELOC, note when the draw period ends, how the repayment period works and whether the rate is variable.