What Is The HELOC Draw Period?

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What is the HELOC draw period?

A home equity line of credit (HELOC) is a financing tool that converts your home’s equity into money you can spend. It works similarly to a credit card: You can borrow as needed up to an approved limit, which is based on the amount of equity you have in your home.

Unlike a credit card, however, a HELOC includes two main phases. The draw period is the first phase of the loan. During this time, you can borrow up to the limit, pay it back and then borrow more money as many times as you want until the draw period ends. That said, you’re typically not required to repay everything you borrowed during the draw period; often you’ll only need to pay interest.

HELOCs often have variable rates. Some come with a lower introductory rate for a period of time, such as six months. And some HELOC lenders allow you to convert some or all of your balance to a fixed rate.

HELOC draw period example

Let’s say you establish a $30,000 line of credit, and you take out $20,000 at a 9 percent interest rate to remodel your kitchen. During the draw period, you’re only required to pay the monthly interest on the amount you borrow, or $150 in this scenario.

What if your kitchen remodel goes over budget? If you’re still in the draw period, you can borrow more money up to the limit. If you borrowed another $5,000, for example, your minimum monthly payments would rise to $187.50.

While you’re not usually required to pay back any principal during the draw period, it’s smart to do so if you can. This will help you avoid borrowing more than you can afford to repay.

What is the HELOC repayment period?

Once the draw period is over, the HELOC will transition to the repayment period. At this point, you can’t borrow against the line of credit anymore. You’ll make monthly payments that include both principal and interest, over a set term, often as long as 20 years.

You can pay off a HELOC prior to the end of the draw period, but beware of early repayment penalty charges. If your HELOC balance is already at zero at the end of the draw period, the account typically closes automatically.

Remember that your HELOC’s interest rate is typically variable, so your payments could increase from month to month.

How are payments during the repayment period calculated?

Once you enter the repayment period, your HELOC payments are calculated on an amortization schedule identical to what’s used for regular mortgages.

Say you owe $25,000 on your HELOC, your interest rate is 9 percent, and your repayment schedule is 10 years. In that case, your principal and interest would be $317 a month.

HELOCs have fluctuating interest rates, however. If your rate rises to 10 percent, your payment would climb to $330 a month. Here’s a breakdown of how monthly payments on a $25,000 HELOC balance could vary:

What to do before your HELOC draw period ends

The draw period termination date of your HELOC is typically listed on your monthly statement. Most lenders notify clients at least six months before the end of their draw period as well.

Jon Giles, head of home lending strategy and support at TD Bank, recommends reaching out to your lender to ask:

• When will the loan move into repayment?
• Will the interest rate reset entering the repayment phase?
• Will my repayment interest rate be fixed or variable?
• What is the change in payment per month?

What to do when the HELOC draw period ends

If you think you might not be able to cover your monthly bill during the repayment period, there are a few ways to refinance your HELOC:

• Open a new HELOC. Some lenders allow you to open a new HELOC and roll over some or all of the old one’s balance. You’ll have to pay interest on the balance, but you’ll be back in the line of credit’s draw period, meaning you can avoid principal payments. While this delays the inevitable, starting a new line of credit might give you breathing room to build income.
• Pay your HELOC off with a home equity loan. Though it also draws on your equity, a home equity loan differs from a line of credit: It pays the money out in one lump sum, which you immediately start repaying at a fixed interest rate. If you go this route, keep in mind that you might increase the amount you pay in interest overall.
• Refinance your HELOC and mortgage into a new loan. Now that interest rates seem to be on the decline, you might consider refinancing: rolling both your credit line and your mortgage together into a new mortgage. This is a more cumbersome option, but it could be a good way to streamline all your debt into a single, big loan. If you can afford it, consider making it a 15-year or 20-year mortgage to reduce the total number of interest payments.
• Explore a cash-out refinance. Cash-out refinancing is the process of taking out a new mortgage for more than you currently owe on your home and receiving the difference in cash. You can use that extra money to pay off your HELOC balance. A cash-out refinance typically only makes sense if you can get a lower interest rate.
• Take out a personal loan. If you qualify for a large enough personal loan, you can use it to refinance your HELOC. This option is best reserved for borrowers whose excellent credit will score them a favorable rate. Otherwise, you’re simply swapping one debt load for a costlier one.

FAQ

• How frequently can my HELOC interest rate change?
  

  Your rate can change as often as monthly. The details are spelled out in the terms of your HELOC agreement. Some lenders offer fixed rates for an introductory period of up to a year, and your rate typically has a lifetime cap.

• What happens if I don’t pay off my HELOC?
  

  If you can’t repay your HELOC, you could face foreclosure – a legal process in which the lender takes possession of your house as compensation for you defaulting on the debt. It’s one of the downsides to financing that’s secured by your home.

Additional reporting by Mia Taylor