If managed properly, the HELOC draw period can set you up for financial success.
A home equity line of credit (HELOC) allows you to borrow capital against the equity that you have built in your home. This revolving credit line is broken into two parts: the HELOC draw period, during which you can borrow money from the approved credit limit, and the repayment period.
“It's similar to using a credit card but with your home equity as collateral,” says Jose Garcia, president and CEO of the Illinois-based Northwest Community Credit Union.
While these funds can help pay for renovations or reduce credit card debt, the HELOC draw period could also cause financial distress if used improperly. Here, we’ll review how this period works and what to know before using HELOCs.
What is a HELOC draw period?
A HELOC draw period is the amount of time you can borrow against your approved HELOC credit limit before paying it back.
The draw period typically lasts up to 10 years and is followed by the HELOC repayment period, when you must repay the borrowed money. “During this phase, which can last up to 20 years, you'll need to repay both the principal and interest,” Garcia says. “This can lead to higher monthly payments, so it's important to plan accordingly.”
Some lenders may require you to make small monthly payments during the draw period.
How Does a HELOC Draw Period Work?
A HELOC draw period allows you to borrow capital against your property. When you’re approved for a HELOC, your lender will give you a credit limit, typically around 80% of the equity in your home.
Your equity is calculated by taking your home’s appraised value and subtracting the amount owed on the mortgage. For example, a house valued at $500,000 with a $200,000 mortgage would have $300,000 in equity. A HELOC loan on such a property would give you a $240,000 credit limit.
You don’t have to borrow this money at once, and paying very little interest is possible if you don’t rush to use the entire limit. Once the draw period concludes, you can no longer borrow money against the line of credit. Any remaining balance must be repaid in monthly installments.
While each lender has different terms and conditions, minimum monthly payments are calculated on an amortization schedule that considers your repayment window and monthly interest rates. In other words, the monthly balance depends on the length of your HELOC repayment period and monthly interest rates.
You can use a HELOC for a down payment, reduce credit card debt or fund renovations to your property.
Tips for Managing the HELOC Draw Period
A HELOC can provide financial flexibility only if you use it wisely. Here are some tips on how to navigate the HELOC draw period.
- Don’t immediately spend the funds: You don’t have to burn through your HELOC’s limit immediately just because you have extra money. HELOCs accrue interest the moment you borrow against the credit limit.
- Don’t use a HELOC to shield bad financial habits: A HELOC can enable a toxic lifestyle filled with poor financial decisions. Some homeowners take out HELOCs and lose their properties because they can’t keep up with monthly payments after the draw period concludes. “Keep track of your borrowing and ensure you can manage the higher payments once the repayment period starts,” Garcia says.
- Consider early repayments: “If possible, try to make higher payments to reduce the principal balance during the draw period,” Garcia advises. “This method will help reduce the amount you'll owe later.”
- Don’t just make minimum payments: The minimum monthly payment on HELOCs is relatively low, especially when compared to a home-equity loan. However, you should treat it like credit card debt and pay off as much as you can. Interest will continue to compound on the unpaid balance, and since rates are variable, you can end up with a higher interest rate over time.
- Keep an eye on interest rates: Most HELOC lenders use variable interest rates, meaning your monthly payments may fluctuate based on each month’s numbers. “Stay informed about changes in interest rates and how they might impact your payments,” Garcia says.
Key Takeaways
When entering the HELOC draw period, here are a few important things to keep in mind:
- The HELOC draw period is when you can borrow money against your approved credit limit, and it typically lasts up to 10 years
- You may still have to make small monthly payments during the draw period
- You can make payments against the principal balance while still withdrawing money
- Monitor interest rates, as they will impact your monthly payments
Why You Should Trust Us
Benzinga has offered investment and mortgage advice to more than one million people. Our experts include financial professionals and homeowners, such as Anthony O’Reilly, the writer of this piece. Anthony is a former journalist who’s won awards for his coverage of the New York City economy. He’s navigated tricky real estate markets in New York, Northern Virginia and North Carolina.
For this story, we worked with Jose Garcia, president and CEO of the Illinois-based Northwest Community Credit Union, which offers multiple financial services, including HELOC loans.
Frequently Asked Questions
What is the HELOC repayment period?
The HELOC repayment period is the time in which you must pay the principal balance, plus interest, of the HELOC loan. This period can last up to 20 years and is preceded by the HELOC draw period, or the time in which you’re allowed to borrow money against your approved credit limit.
How are payments during the repayment period calculated?
Monthly payments during the HELOC repayment period are calculated using an amortization schedule set by the lender. Two major factors are the length of the repayment period and monthly interest rates. Some lenders, however, may have different terms and conditions.
Sources
- Jose Garcia, president and CEO of Northwest Community Credit Union
About Anthony O'Reilly
Anthony O’Reilly is an updates editor for Benzinga. He’s won numerous journalism awards for his coverage of the New York City economy and Long Island school district budgets.