How does a HELOC draw period work (versus a repayment period)?
A HELOC, or home equity line of credit, is a type of home equity loan. During a HELOC draw period, you are able to withdraw cash as you need it, up to your determined credit limit. This is followed by a repayment period, where you can no longer withdraw funds.
Key Takeaways
A home equity line of credit (HELOC) is divided into two distinct periods: the draw period at the beginning of the loan and the repayment period at the end
During the draw period you can withdraw funds from your credit line, up to your credit limit
Interest-only monthly payments will be charged during this period on the principal balance that you have borrowed
Every lender has specific requirements about how to make withdraws, including frequency, minimums, and fees
It is best to make principal payments during this time if you can to avoid financial burden when you enter the repayment period
How do HELOC draw periods work?
A Home Equity Line of Credit (HELOC) is a type of home equity loan that gives you access to funds for projects and investments. A HELOC is a line of credit, so instead of receiving a single payment upfront, you draw funds up to a maximum credit limit as needed. The period of time when you can withdraw funds is called the draw period, and it is followed by the repayment period, during which you pay off the loan.
Most HELOCs give you a draw period of 10 years, though the length can vary. During this time you can draw as much money from the credit line as you need, up to your credit limit. Minimum monthly payments during the draw period are required only on interest accrued on your balance.
Once this initial period ends, you will have to repay what was drawn from the HELOC, plus interest. For example, if you get a $150,000 HELOC and only spend $25,000 then at repayment time it is only that amount that has to be paid back with the accruing interest.
Lenders vary in requirements, terms, and fees, so borrowers should shop around for the credit line that makes the most sense for them. For example, some HELOCs may require an initial minimum amount to be taken when the account is opened up. Some might require a large "balloon payment" after the draw period closes, while others might impose early repayment penalties for paying down your principal during the draw period. Borrowers should have an understanding of how they plan to use and pay back their home equity loan to determine which HELOC meets their needs.
How do you draw funds from your HELOC?
Another thing that varies by lender, is how you access your HELOC funds. Some banks will provide a debit card allowing you to get cash from an ATM or bank branch, some provide you with checks, and others allow you to transfer funds electronically into your checking account.
The home equity line application and approval process can move fairly quickly to give you access to cash soon. Online lenders, such as Figure, can process the loan in as quickly as 5 days, while traditional banks usually take 2-6 weeks. The process is heavily dependent on how quickly you are able to provide documentation to the lender, such as income verification.
Once the approval process is complete, you can access your HELOC funds immediately. Be certain to understand the specific draw requirements of your lending institution, such as the minimums or maximums allowed in each draw. Some lenders require an immediate initial draw, others limit the total number of draws you can make, and others have rules in terms of the frequency of draws. Also, make sure to understand if there are draw fees associated with making a draw.
Will my payments change during the draw period?
Payments during the draw period are interest-only payments on the balance of your HELOC. Because of this, minimum payments will change as your balance changes. If you withdraw more funds, then your interest will increase, and so will your minimum required payments. If you make a payment toward your principal balance, your balance goes down, and so will your payment.
The monthly payment will also depend on if you have a variable or fixed interest rate. Variable interest rates can change as often as every month, depending on the prime rate index they are based upon. As the interest rate goes up, so will monthly payments. There are many variable and fixed-rate home equity line options, but many people find the benefits of a predictable fixed rate outweigh the potential for interest rates to go down.
Can you pay off or pay down a HELOC during the draw period?
Yes, usually lenders allow borrowers to make payments toward the principal balance on their HELOC during the draw period (however, it is not required to do so). Some lenders have early repayment fees, meaning they charge you either a percent of your credit limit or a flat fee if you pay off your balance before the close of the draw periods. Others allow you to pay off your balance in full during the draw period without any penalty.
As a general rule, paying off debt as quickly as possible can save you a significant amount in interest in the long run. Even if your HELOC has fees or penalties for early repayment, it still may be a better financial decision to pay off (or at least pay down) your HELOC during the draw period. This reduces your risk of being unable to make larger payments when you enter the repayment period.
What happens when a draw period ends?
When the draw period ends, you enter the repayment period. Most HELOCs have a repayment period of 20 years, but this can vary by the specific terms of each loan. If you haven't been paying down the principal balance during the draw period, you should be prepared for substantially larger payments once you enter repayment.
As the end of your draw period approaches, it's a good idea to refresh your understanding of your loan repayment terms. Understand how much you will owe once the draw closes, how long your have to repay the full balance, and how much your monthly payments will be.
If you are concerned about being able to make minimum monthly payments to pay off your credit line, contact the lender immediately. Banks want their money bank and are usually willing to work with you in order to accommodate your needs. For example, they may be willing to renew your draw period, convert a variable-rate HELOC to a fixed-rate HELOC, or refinance your existing loan.
How do HELOC repayment periods work?
After the draw period of a HELOC is over, you enter the repayment period. During this time, both your principal and interest begin to be due on a fixed schedule, typically ranging from 10 to 20 years. Your monthly repayment amount will largely depend on how much you have borrowed during the draw period, so be sure to review your terms carefully when setting up the loan. During the repayment period, it's important to remember that you won't be able to make any additional draws against your loan balance.
The bottom line
A home equity line of credit, or HELOC, is a revolving credit line that is secured by the equity you have built up in your home. During the first period of the loan, you are able to withdraw money up to your credit limit and are only required to make payments on interest. After this draw period comes to an end, you will need to pay off your outstanding balance in agreement with the terms of your line of credit. Accessing funds during the draw period is usually simple, however, it can be easy to get in over your head due to interest-only payments. Experts recommend only withdrawing what you need, as you need it, to avoid paying unnecessary interest, and to try to pay down the balance on your HELOC during this time to reduce monthly payments (and overall interest) down the line.
