What is a HELOC, and Should I Get One?

Learn what a Home Equity Line of Credit entails and if you should apply for one.

by Spero Financial

Home Equity Loans and HELCO Explained

For many homeowners, having access to additional funds is a must—whether they are for a new home project or simply to cover a large or unexpected cost that comes up. However, instead of grabbing the nearest credit card or taking out a high-interest personal loan, homeowners have access to an even better source of financing—loans based on the equity they have built into their home.

These loans, typically known as a Home Equity Loan or a HELCO (Home Equity Line of Credit), use the value of the home—minus any financing taken against it already—to create a fund based on a portion of the equity held within. And because they are based on equity the home has already, the interest rates and terms for such loans are far more manageable for the borrower than any other standard loan. In this article, we’ll explore home equity financing, your options, and how you can use them to your advantage.

What is a HELOC loan?

A HELOC, or Home Equity Line of Credit, is a source of funding based on the established equity of a homeowner’s property. A HELOC is a revolving line of credit that helps you pay for large expenses or consolidate debt, by using the equity you’ve built in your home as a baseline for what you can borrow and your home as collateral for the loan. The HELOC is one option that consistently offers high funding amounts with lower interest rates. However, it is only one type of funding based off Home Equity—there are others that operate differently from each other—so it’s important to understand the details of each in order to pursue the type of loan that is right for you.

Am I eligible for a Home Equity loan?

Like any other loan, eligibility for a home equity loan—often called a second mortgage—depends on a number of factors, including income, credit history, and credit score, and employment. Should you be granted a home equity loan, the financier will consider your CLTV (combined-loan-to-value) ratio to determine how much you would be eligible for, according to their guidelines. The CLTV takes into consideration all of the secured loans against a single property, and how they compare to the overall value of the property itself.

To calculate the CLTV, here is the formula you’d follow:

CLTV = VL1(Value of Loan 1) + VL2 (Value of Loan 2) + VLn

                        Total Value of the Property

To see this as an example, let’s consider a home that has an appraised value of $300,000. However, the owners have a primary mortgage balance of $100,000, and a HELOC with a balance of $20,000. The formula would read:

CLTV = 100,000 +20,000


In this case, the CLTV is 40%, meaning that 60 percent of the home’s value is unencumbered by loans, and there is enough equity that a lender would likely make the loan. Generally, lenders will finance at a CLTV of 80% or above to borrowers—if they have high credit ratings.

How much financing does a HELOC provide?

Since a HELOC is based on your home equity and assets, the amount of financing a HELOC provides depends on how much equity you have built up in your home. For example, if your home’s appraised value is $200,000, and you still owe $120,000, then you have $80,000 in equity. However, that doesn’t necessarily mean you can walk in and out with a line of credit for that full amount. Typically, a financial institution (bank or credit union) will only allow you to borrow up to 85 percent of your existing equity. That means for the $80,000 you have in equity, you may only qualify for a HELOC of $68,000.

Of course, you don’t have to accept a HELOC for that full amount if you don’t need to. One of the best parts of a line of credit is that you can withdraw from it as needed and make monthly payments only on what you’ve borrowed. So, if you do end up taking out that full $68,000 on a line of credit, but only need to use $20,000 to renovate your master bathroom, you only owe payments back on that $20,000 — not the full $68,000. Then, if you decide to pay off a high-interest credit card with another $3,000, you just add that to the amount you owe. In short, a HELOC is a great way to have liquid financial assets and only pay for them if you need to use them.

Is a HELOC better than a Home Equity Loan?

Typically, you’ll hear about a HELOC in comparison with its financial cousin, the Home Equity Loan, but they are very different. In addition to these popular options, there are a number of financing alternatives that you can use to find the cash for larger projects or goals — and all of them have their own pros and cons. 


A HELOC is based on the equity you have in your home and is paid out in a revolving line of credit that you can access and pay back over a set amount of time (usually 15 or 30 years). Your payments are based only on the money you have spent, and you can spend, payback, and spend again, should you choose to. Finally, home equity lines of credit are usually subject to a variable rate, which is based on the current market.

Home Equity Loan

Similar to a HELOC, a home equity loan also depends on the equity you have in your home. The main difference is it is paid out in a lump sum and payments are based on the full loan amount. Payments also begin immediately. Unlike a HELOC, there is no fluidity to the credit — once it’s been distributed and paid back, the loan is considered executed in full. One of the benefits, however, is that a home equity loan is typically based on a fixed rate of interest and has set monthly payments — so there are no surprises on how much you owe month-to-month.

Comparing the Two Types of Home Equity Loans

 Home Equity LoanHELOC
RatesFixedFixed or Adjustable
DisbursementOne lump sum paid out upon closingA funded revolving account; funds can be used, paid off, and re-used
PaymentsFixed monthly payments based on the total amount of the loanMonthly payments based on the amount of the fund actually used
Closing CostUsually 2% to 5% of the total amount of the loanUsually 2% to 5% of the total amount of the loan (although some lenders do not require a closing for a HELOC)
Best If..You have a project with a hard budget requirement, or know how much you’ll need and for whatYour project is flexible or indeterminate, or you want to have an extra account to pull money from for various projects and/or needs

Other Options for Equity-Based Loans

It’s important to realize that a Home Equity Loan and a Home Equity Line of Credit aren’t the only options available to homeowners who need a little extra cash. Here are a few more options that you might consider if you’re looking for a boost.

Cash-Out Refinancing

While a cash-out refinance scenario is also based on the amount of equity you have in the home, the process is quite different. It requires a full refinancing of your home. Once you have gone through the full process of appraisal and evaluation, any equity remaining is “cashed out” as your financial institution restructures a new payment plan. That cash is given to you as a singular lump sum.

Personal Loan

Another option for a larger project budget is a personal loan, although these tend to have higher interest rates than loans or lines of credit based on home equity. For a secured personal loan, the financial institution will require collateral to leverage for payment — a car, a Certificate of Deposit, or some other asset of value. In an unsecured loan, you won’t be required to put up any collateral, but you’ll likely trade-off by paying a higher interest rate instead.

Sinking Fund

With a sinking fund, you forgo any loan or line of credit, and instead set up a personal savings account for a specific purpose. If you know that your new living room makeover will likely cost around $5,000, you’ll save $416 every month for a year. Unlike the other options as listed above, a sinking fund won’t show up on your credit and can be an excellent way to spend guilt-free.

What are the phases of a Home Equity Loan?

There are two phases of a home equity loan: the Draw Period, and the Repayment Period. How they work in the practical sense is a bit different, however.

On a HELOC, the draw period can last up to 10 years, allowing the borrower to pull money in bits as they need to. During that time, payments on the interest are made. After that stage, the repayment phase begins. During this phase, the borrower no longer has access to withdraw or use funds, and instead must focus on full repayment of the balance.

While a Home Equity loan is very similar, because the draw happens immediately, the repayment phase may not be delayed for a long period of time before monthly payments against the balance are expected (with interest!).

As always, these details can change based on the lender, the type of loan, and a variety of other indicators. For that reason, it is important to discuss all the options—and terms of the agreement—with your lender, before you sign on the dotted line.

What can a HELOC be used for?

A home equity line of credit can be used for virtually anything, but it’s important to gauge whether or not a particular debt is worth using a HELOC for. (For example, if the orthodontist is offering you a 0 percent interest payment plan, it may not make sense to pay for it out of a HELOC at 4 percent instead). Still, a HELOC is a widely-used option for mid- to large- purchases. Some of the most popular uses include:

  • Home renovations
  • Paying off high-interest credit cards
  • Vacation pay-off
  • College debt or incidentals
  • Special projects
  • Medical procedures or needs (orthodontia or minor surgery)

How do I get a HELOC?

The process for getting a home equity line of credit is relatively straightforward — and therefore, pretty simple. Although it may take a few weeks to get all the necessary pieces in order, you can expect a similar process, no matter where you apply.

1.Get things in order

Getting a home equity line of credit isn’t an instantaneous process, so before you even apply, you’ll want to know if you are financially healthy enough to make it worth your time. Check your credit score and the current market rates on your home. Know how much you still owe and approximately what your home is worth so you can estimate your equity. You may find that you don’t have enough equity built up to match the monetary value you’re trying to get out of your loan or line of credit. If that’s the case, it’s better to know this before you begin the process.


After the first step, you’ll fill out an application, either online or in the branch of the financial institution. Smaller lenders may request an in-person meeting to go over the details; others may have everything entirely online. It is also completely normal to have to provide tax returns, pay stubs, proof of ownership, or other forms of validation. Still, the application is pretty standard, and they’ll use this information — as well as a credit check — to validate whether your request is feasible. Also, keep in mind that some institutions may charge an application fee — sometimes near $100.

3.Initial decision

After you’ve submitted your application and all the necessary paperwork, an underwriter will review your application and make a decision as to whether or not you are a wise investment for that institution. Sometimes, the underwriter is a person in your branch; other times, outside underwriters can be utilized. A local underwriter is beneficial because they can consider regional knowledge and get to know the specifics of your financial situation. But whether they are on-site or remote, the underwriter will be the first “yes” or “no” you receive in this process. If it’s a “yes,” they will then outline the terms of the agreement — how much they will offer and for how long, at what interest rate. If it’s a “no,” then it’s likely that they will also provide some suggestions for increasing your creditworthiness — like raising your credit score or paying off debt.

4. Appraisal and verification

If the underwriter gives you a “yes,” then it’s onward and upward. A formal appraisal will be scheduled to ensure your house is valued at the same amount as was applied for. Additionally, all the paperwork will be reviewed and validated. All of this is to verify the amount of equity you actually have in the house.

5. Closing

When it’s time for the formal closing, you’ll likely sit down with an attorney who will go through all the legal paperwork with you and have you sign everything in order. You, and anyone listed on the HELOC with you, will need to attend the closing.

6. Project time

It’s finally here — you have the cash to make magic happen! You may get some checks to use for your project or simply go to the branch and take your money out as you need it. Keep up with your payment and what you’ve spent, and you’ll be a HELOC pro in no time.

Whatever your financing goals may be, the member service representatives here at Spero are here to help you achieve them! If you want to boost your savings, start a sinking fund, or apply for a HELOC or Home Equity Loan, we can help! Stop by any of our branches, give us a call to find out more, or apply online today.

Find Financial Freedom Through Better Banking.

Join today, and start enjoying all the benefits of membership!