Your Guide to Getting a Home Equity Line of Credit (HELOC)

If you're a homeowner you might wonder if it's a good idea to dip into your equity using a HELOC. Laura explains what a HELOC is, how to get one, recent tax changes, if you should use one to pay off a primary mortgage faster, and the main pros and cons to consider.

Laura Adams, MBA
9-minute read
Episode #558

3. Your income.

Just like with all creditors, the amount you earn is key for getting a HELOC. You must be able to show that you earn enough to cover your current debts, plus the additional line of credit you’re seeking.

You’ll typically need to show at least two years of banking records or tax returns to prove that your income is high enough.

4. Your ability to repay.

HELOC lenders also consider if you’re likely to have the ability to repay a debt in the future. They review how consistent your income has been over the past few years. Plus, they look at assets you own, such as savings and investments, that you could liquidate to maintain debt payments if needed.

5. Your credit score.

Another important way that all creditors, including HELOC lenders, evaluate your financial responsibility and willingness to repay debt is your credit score. While the minimum score varies, the higher the better for getting approved at the lowest possible interest rate.

If your credit isn’t good, you may still be eligible for a HELOC if you have plenty of income and home equity. All the factors I’ve covered are taken into account. So being slightly deficient in one financial area may be okay if you’re strong in another.

How Do You Pay Back a HELOC?

After you tap your home equity with a HELOC, you must pay some portion back each month. There are typically two phases for repayment: the draw period and the repayment period.

The draw period is when you’re allowed to continue borrowing from a HELOC, up to the total line amount, with interest-only payments. For instance, if you have a HELOC with a 20-year term and a 10-year draw, you would just have to pay minimum interest payments for the first 10 years.

After the draw period ends, you can no longer borrow against your HELOC, and the repayment period begins. Your payment changes to amortize, which means it’s composed of principal and interest, over the remaining 10 years. That ensures that your balance is paid off by the end of the term.

But HELOC terms can vary depending on the lender. Some may have a balloon payment, which is a larger-than-usual payment at the end of the term. And some HELOCs may not have a repayment period, but require full payment at the end of the draw period.

Changes to the HELOC Interest Tax Deduction

One big benefit of getting a HELOC is that it may come with a tax deduction. However, the rules for homeowners changed due to the Tax Cuts and Jobs Act of 2017, which went into effect in 2018. It reduced the cap on deductible mortgage interest from $1 million to $750,000 for those filing a joint return, and $375,000 for single taxpayers.

The new law also changed how HELOCs and home equity loans are treated. Previously, you could deduct all the interest paid on up to $100,000 for home equity loans or HELOCs. It didn’t matter how you spent the money; the interest was deductible whether you used it for home improvements or a trip around the world.

Beginning in 2018, the ability to deduct interest on anything other than home-related expenses has been suspended until 2026.

Beginning in 2018, the ability to deduct interest on anything other than home-related expenses has been suspended until 2026. Until that time, HELOC debt must be used to buy, build, or substantially improve your home in order for the interest paid to be tax deductible.

The new regulations also allow you to combine the total of all types of home acquisition debt, including mortgages, home equity loans, and HELOCs, and deduct interest paid on a maximum amount. As I mentioned, you can deduct interest paid on up to $750,000 of acquisition debt if you file taxes jointly, or up to $375,000 if you file as a single.

For instance, let’s say you have a $500,000 mortgage and get a $150,000 HELOC to remodel your home. You could deduct the interest on up to $650,000, or all of your home-related debt.

But if you have a $200,000 mortgage and use $25,000 from a HELOC to pay for college expenses, none of the interest paid on the HELOC would be deductible. Again, you can spend a HELOC on anything you like, but only the portion within the total limit that’s used for home-related expenses is eligible for an interest tax deduction.

So, if you’re considering a HELOC, understand that the tax law recently changed. You may not be eligible to deduct your interest expense, depending on how you use the money, and whether you itemize deductions on your tax return.


About the Author

Laura Adams, MBA

Laura Adams received an MBA from the University of Florida. She's an award-winning personal finance author, speaker, and consumer advocate who is a frequent, trusted source for the national media. Money-Smart Solopreneur: A Personal Finance System for Freelancers, Entrepreneurs, and Side-Hustlers is her newest title. Laura's previous book, Debt-Free Blueprint: How to Get Out of Debt and Build a Financial Life You Love, was an Amazon #1 New Release. Do you have a money question? Call the Money Girl listener line at 302-364-0308. Your question could be featured on the show.