HELOCs and home equity loans

U.S. homeowners accumulate equity in their homes as principal is paid down and as values appreciate. That equity can be tapped through one of two principal products: a home equity loan (a closed-end second-lien loan with a fixed amount and fixed term) or a home equity line of credit (a revolving line backed by a second lien). Both put the home at risk in a way an unsecured loan does not — the borrower's failure to pay can lead to foreclosure on the second lien — and both produce rates that are typically several percentage points lower than unsecured alternatives because of that collateral exposure.

This article describes the HELOC structure (draw period, repayment period, variable-rate dynamics), the home-equity-loan alternative, the lien-position implications, and what happens on default. For the primary mortgage on the same property, see mortgages: the basics; for the broader secured-vs-unsecured framework, see secured vs unsecured credit.

HELOC structure

A standard HELOC has two phases. During the draw period (typically 10 years), the borrower can draw funds from the line up to the approved credit limit, repay, and re-draw. Monthly payments during the draw period are typically interest-only on the outstanding balance, with no principal amortization required. At the end of the draw period, the line converts to the repayment period (typically 10 or 20 years), during which no new draws are permitted and the borrower amortizes the outstanding balance with principal-and-interest payments.

The interest rate on a HELOC is typically variable — most often set at the prime rate plus or minus a margin. When the federal funds rate moves, the prime rate moves with it within a billing cycle, and the HELOC's interest charge adjusts. Borrowers who took out HELOCs during the low-rate period of 2020–2021 and held the balance through the 2022–2024 rate-hiking cycle saw their interest costs rise substantially. Some HELOCs offer a fixed-rate conversion feature, allowing the borrower to convert all or part of the outstanding balance to a fixed rate at a defined point.

The combined loan-to-value ratio (CLTV) — the sum of the first-mortgage balance and the HELOC limit divided by the property value — is the principal underwriting constraint. Lenders typically cap CLTV at 80% to 85% for HELOC underwriting, leaving the borrower with at least 15% to 20% equity remaining after the line is fully drawn.

Home equity loan: the fixed-amount cousin

A home equity loan is a closed-end second-lien loan: the borrower receives the full advance at closing, repays at a fixed rate over a fixed term (typically 10 to 30 years), and has no ability to redraw. The product is structurally similar to a small mortgage; the principal differences are the second-lien position and the typically smaller loan size relative to a primary mortgage.

Home equity loans suit borrowers who want a defined amount of funds for a specific purpose (a major home renovation, debt consolidation, or other one-time use) with payment certainty. HELOCs suit borrowers who want ongoing access to a line of credit and are willing to accept variable-rate exposure.

The second-lien position

Both HELOCs and home equity loans typically take a second lien on the property — the first lien being the primary mortgage. The lien position matters in two contexts.

In foreclosure, lien priority determines payment order. If the first-mortgage holder forecloses and the property sells, the first-mortgage holder is paid in full from the proceeds first; the second-lien holder is paid from whatever is left over; if proceeds are insufficient, the second-lien holder takes nothing. The second-lien holder can also independently initiate foreclosure if the borrower defaults on the second lien, although this is less common because the first mortgage typically remains current.

In refinance, the second-lien holder must agree to "subordinate" — to remain in second position behind the new first mortgage — or the refinance cannot proceed without paying off the second lien. The subordination decision is at the second-lien holder's discretion and may carry fees.

The right of rescission

Under Regulation Z, a borrower has a three-business-day right to rescind a HELOC or a home equity loan secured by the principal dwelling. The right runs from the latest of consummation, delivery of the required TILA disclosures, or delivery of the rescission notice; if the lender fails to deliver any required disclosure, the rescission right extends to three years. The rescission right does not apply to purchase-money mortgages or to refinancings with the same creditor that do not advance new money.

The 2008 lesson

The 2008–2009 housing crisis produced substantial defaults on HELOCs and home equity loans, with many second-lien holders taking near-total losses as falling home values left the first-mortgage holder underwater and no equity for the second lien. The HELOC market substantially contracted in the years following 2009, with banks tightening underwriting and reducing draw-period extensions to existing borrowers. The market has rebuilt since, but underwriting standards have remained tighter than the 2005–2007 peak, with stricter CLTV limits and more conservative debt-to-income requirements.

The 2022–2024 rate-hiking cycle illustrated the variable-rate risk in the HELOC product. Borrowers who drew large balances at 4% interest in 2021 found themselves paying 9%+ on the same balance by 2023; for borrowers who had budgeted for the lower rate, the increase produced material payment shock. The CFPB has issued guidance reminding HELOC borrowers to evaluate their ability to service the balance under the rate's lifetime cap, not just the prevailing rate at draw.

Limits and uncertainty

The HELOC and home-equity-loan products are stable; the underwriting cycle continues. Live developments include the gradual rollout of new products (some lenders offering fixed-rate HELOCs at origination, blurring the line with home equity loans) and the recurring CFPB attention to second-lien servicing practices. Rates continue to move with the federal funds rate; borrowers should track the prime rate (typically the federal funds target upper bound plus 3 percentage points) to understand their HELOC's rate trajectory.