The hidden costs of HELOCs and home equity loans: What borrowers should check

A home equity line of credit (HELOC) or home equity loan gives you access to funds based on the amount of your home that you own, or equity. The funds you have access to are secured by your home. 

Either of these is a great option for homeowners looking to fund expenses such as home repairs or renovation, medical bills, education or emergencies.  

HELOCs and home equity loans could come with lower interest rates than some other types of loans. And if you decide to use your HELOC or home equity loans funds for home improvements, the interest could be tax-deductible.¹ 

But the interest rate is only one part of what a HELOC or home equity loan costs. Upfront fees, how the rate can change, what happens to your payment when the HELOC draw period ends and the fact that your home serves as collateral for the loan could also affect the total. Checking each of these before you sign helps you compare offers on equal terms. 

If you are ready to access the value built up in your home with a HELOC or home equity loan, start your application today! 

HELOC vs. home equity loan: What is the difference?

A HELOC lets you borrow money with a line of credit based on the amount of equity you've built up in your home. It gives you flexible access to funds, unlike traditional home loans that give you a single lump-sum. 

You can take out money as needed more than once during your draw period, which with a HELOC usually lasts from five to 10 years. You usually pay only interest on a HELOC during your draw period, then pay back both principal and interest once you transition to the repayment period. 

A home equity loan allows you to borrow a set amount in a lump-sum based on the equity in your home. 

A home equity loan could be better than a HELOC if you need funds for a one-time payment, like school costs, a big home renovation or consolidating your personal loan debt.  

Another advantage of a home equity loan is that it usually comes with a fixed interest rate, which means your loan payments stay the same over time.  

Both options are known as a second mortgage, so you will pay back the loan alongside your original mortgage. 

Here is a breakdown of the key differences between a HELOC and a home equity loan. 

Which upfront costs should I check?

Ask for a written estimate of every cost due at or before closing. Here are some common items to look for. 

• Origination fee. This is a charge for processing the loan. Some lenders deduct it from the amount you receive, which means your usable funds are lower than the stated loan amount.
• Appraisal. The lender may require a professional valuation of your home.
• Title search and title insurance. These confirm ownership and lien position.
• Credit report and application fees.
• Recording fees. Local governments charge these to record the new lien.

Fees amounts vary by lender, property and state. Ask your lender for its fee schedule. Compare the total cash you would need at closing and the net amount you would receive. 

Can the interest rate cost more than it first appears?

The cost of a HELOC or home equity loan depends on a number of factors, including the rate. Here are three things to check about the rate. 

Fixed or variable. A fixed rate stays the same. A variable rate moves with an index, commonly the Wall Street Journal Prime Rate, plus a margin set by the lender. When the index rises, your rate and payment can rise as well. 

Which amounts the rate applies to. Some HELOC structures price the first draw and later draws differently. For example, on Rate's HELOC, the full loan amount minus the origination fee is drawn at origination at a fixed rate.  

For additional draws during the draw period, the fixed rate is based on the Wall Street Journal Prime Rate for the preceding calendar month plus a fixed margin, and it may be higher than the initial draw rate.  

Rate's variable-rate HELOC requires 100% of the approved amount to be disbursed at closing. 

Introductory pricing. Ask how long any promotional rate lasts and which rate applies afterward. 

What happens to my payment when the HELOC draw period ends?

Many HELOCs allow interest-only payments during the draw period. When it ends, payments increase to include principal and interest. Rate's variable-rate HELOC works this way. 

For illustration, interest on a $50,000 balance at 8% a year is about $333 a month. Once principal is added, the monthly payment would be higher.  

Run your own numbers with Rates's HELOC calculator before you borrow. Remember that the calculator is an educational tool, not a loan offer. 

A useful test is to ask whether you could comfortably afford the payment after the draw period ends, and at a higher rate if you select the variable-rate option. 

Which ongoing and exit costs should I ask about?

These fees are less visible at application, so ask about them directly. 

• Annual or maintenance fees
• Inactivity fees if you do not use the line of credit
• Minimum draw or minimum balance requirements
• Early closure or prepayment fees
• What the lender charges if you pay off the balance and close the account early

What does using my home as collateral cost me?

HELOC and home equity loans are secured by your home. If you cannot make payments, the lender may have the right to foreclose, and in some cases, you could lose your home.  

Here are some other costs to consider. 

• Insurance. Homeowner’s insurance is required on Rate's HELOC, and flood insurance may be required for properties in flood zones. 
• Future flexibility. A second lien must be paid off when you sell your home or refinance your first mortgage.
• Equity. Borrowing reduces the equity you hold in the home, which matters if home values change.

Which eligibility factors change what you pay?

Credit score, debt-to-income (DTI) ratio, occupancy status, lien position and loan-to-value (LTV) ratio all influence eligibility, rate and the maximum amount you can borrow.  

For Rate's HELOC, these factors apply across primary residences, second homes and investment properties. Property type, LTV ratio, minimum credit score and DTI ratio requirements apply as well.  

Two borrowers asking for the same amount could receive different terms, so compare personalized estimates rather than advertised rates. 

Which questions should I ask before getting a HELOC?

Ask every lender these questions, and ask for the answers in writing. 

1. Is the rate fixed or variable? If variable, what is the index, margin and rate cap?
2. What is the origination fee, and is it deducted from my funds?
3. What other closing costs should I expect, and what is the estimated total?
4. How long is the draw period, and when does repayment begin?
5. What will my payment be after the draw period at today's rate and at a higher rate?
6. Are there minimum draw requirements?
7. Are there annual, maintenance or inactivity fees?
8. Is there an early closure or prepayment fee?
9. What insurance does the lender require, including flood insurance if my home is in a flood zone?
10. Which of my credit, income or property details most affect my rate and borrowing limit?
11. How soon could funds be available, and what could change that timing?
12. Who can I speak to if I have questions during the process?

When might a different option fit better?

If you want a single lump-sum with predictable payments, a home equity loan may suit you. If you expect to borrow in stages as your expenses increase, a HELOC may fit.  

If you want to replace your current mortgage and get funds back, a cash-out refinance is a different option with its own costs.  

How can Rate help with a HELOC?

If you are considering tapping your equity to help with expenses, Rate's HELOC application takes just a few minutes to compete, and you could get funds in as little as five days.⁴ 

Rate's Home Equity Alert⁵ can let you know when it may be a good time to take advantage of the equity you have built up in your home. 

¹Rate does not provide tax advice. The consumer should always consult a tax advisor for information regarding the deductibility of interest and other charges in their particular situation. 

²The variable rate home equity line of credit (HELOC) is an open-end product where the borrower can withdraw funds and make interest only payments during the draw period. Monthly payments will increase to include both principle and interest payments after the draw period has ended. A minimum 90% of the total approved HELOC amount must be disbursed. The remaining 10% of the approved credit line can be drawn down later as needed during the draw period. The monthly variable interest rate is based on an Index, which is the Prime Rate published in the Wall Street Journal plus a fixed margin. This product is currently only available in Arizona, California, Illinois, Massachusetts, and New Jersey. The HELOC requires you to pledge your home as collateral, and you could lose your home if you fail to repay. Property insurance is required as a condition of the loan and flood insurance may be required if your property is located in a flood zone. Borrowers must meet minimum lender requirements in order to be eligible for financing. Available for primary, second homes and investment properties only. Property type, loan-to-value, and FICO restrictions and requirements apply. Dependent on minimum credit score and debt-to-income requirements. Occupancy status, lien position and credit score are all factors to determine your rate and max available loan amount. Not all applicants will be approved. Applicants subject to credit and underwriting approval. Contact Rate for more information and to discuss your individual circumstances. Restrictions apply. 

³Rate home equity line of credit (HELOC) is an open-end product where the full loan amount (minus the origination fee) will be 100% drawn at the time of origination. The initial amount funded at origination will be based on a fixed rate; however, this product contains an additional draw feature. As the borrower repays the balance on the line, the borrower may make additional draws during the draw period. If the borrower elects to make an additional draw, the interest rate for that draw will be set as of the date of the draw and will be based on an Index, which is the Prime Rate published in the Wall Street Journal for the calendar month preceding the date of the additional draw, plus a fixed margin. Accordingly, the fixed rate for any additional draw may be higher than the fixed rate for the initial draw. This product is currently not offered in the states of New York, Kentucky, West Virginia, Delaware, Maryland and Maine. The HELOC requires you to pledge your home as collateral, and you could lose your home if you fail to repay. Property insurance is required as a condition of the loan and flood insurance may be required if your property is located in a flood zone. Borrowers must meet minimum lender requirements in order to be eligible for financing. Available for primary, second homes and investment properties only. Dependent on minimum credit score and debt-to-income requirements. Occupancy status, lien position and credit score are all factors to determine your rate and max available loan amount. Not all applicants will be approved. Applicants subject to credit and underwriting approval. Contact Rate for more information and to discuss your individual circumstances. Restrictions apply. 

⁴Applications may be completed in five minutes but may fluctuate. Five business day funding timeline assumes closing the loan with our remote online notary. Funding timelines may be longer for loans secured by properties located in counties that do not permit recording of e-signatures or that otherwise require an in-person closing. In addition, funding timelines may be longer if we cannot readily verify that your property is in at least average condition with no adverse external factors with a property condition report and may need to order a desktop appraisal to confirm the value of your property. Texas borrowers will have a 12-day cooling period prior to closing on their home equity loan which will begin after the borrower has both filed a loan application and received consumer disclosures.   

⁵Home values, equity, and loan-to-value are estimates based on independent data sources and automated valuation models (AVMs), and are not official valuations conducted by Rate. Your property value and condition will be verified through additional AVMs, data sources, and/or an appraisal before any lending decision is made. Estimated equity reflects the difference between the estimated value and loan balance.