You can take out funds from a home equity line of credit (HELOC) during the draw period to help pay for life’s expenses. But once the draw period ends, the repayment period begins—and borrowers are expected to pay back principal and interest costs. Understanding how the phases of a HELOC work can help you financially prepare for your monthly payments.
What is a HELOC?
A home equity line of credit (HELOC) is a revolving credit backed by your home’s collateral. The credit limit you are approved for is partially reliant on the amount you have in home equity—the difference between the value of your home and how much you owe on your mortgage.
For instance, let’s say your home is valued at $250,000, and when you opened your HELOC, you had a balance of $80,000 on your mortgage. So your home equity would be $170,000.
That said, most HELOCs are limited to a certain percentage of your equity by financial institutions, typically up to 80% for the average borrower. Using our previous example, you may be able to take out a HELOC for up to $136,000—not taking into account individual factors such as your income, credit score, and current housing market conditions.
HELOCs can be broken down into two phases: the draw and repayment periods.
Draw period: You can withdraw funds from the credit line and monthly payments during this phase generally go toward interest.
Repayment period: You can no longer withdraw funds and are required to begin making payments toward the principal and interest.
How do HELOC draw periods work?
“A HELOC draw period is the time when a customer can draw as much funds as they need, up to the total available credit line they were approved for during the application process,” says Ryan Jewison, head of Better HELOC for Better Holdco, Inc.
HELOC draw periods function similarly to credit cards—both have credit limits and charge annual percentage rates (APRs) on balances owed. However, it’s important to note that unlike credit cards, HELOCs use your home as collateral if you fail to make your payments.
Suppose you hit the credit limit before your repayment period. In that case, you are able to make payments toward the balance and continue borrowing funds as often as you need until the HELOC draw period ends. This helps fund major home improvement or remodeling projects, or just about any other expense that arises.
Draw periods are available for a fixed amount of time, usually ranging from five to 20 years. During this phase of the HELOC, you may be charged interest on funds withdrawn from the account and potentially a minimum monthly payment, depending on your lender’s requirements.
For instance, let’s say you borrowed $25,000 from your HELOC and are charged an 8% interest rate over a 10-year draw period with a 10-year repayment period. During the draw period, you would owe $166.66 in interest each month, not accounting for any required monthly payments.
How to access funds in a HELOC
During the draw period, you can easily access funds from this account both in-person and online. Most financial institutions provide you with a bank or ATM card that you can use to withdraw cash from ATMs or for purchases in stores and online, similar to a debit card.
You may be able to make online bank transfers directly from your HELOC into your checking or savings account, and some lenders may also allow you to write checks from the account, says Jewison.
What happens when a HELOC draw period ends
Your HELOC will move into the repayment period when your draw period ends. After that, you can no longer withdraw any funds from the line of credit and must make monthly payments toward the principal and interest owed. This means you should anticipate that your monthly payment will increase after the draw period ends, says Jamison.
How to prepare for the repayment period
You don’t have to wait until your repayment period officially begins to start making headway toward paying off your HELOC. And, you might even be able to save money on interest while paying off your debt sooner.
1. Increase your monthly payments
During your draw period, your lender may only require you to make payments toward the interest owed on balances borrowed and possibly a low required monthly payment. But you can begin making payments toward the principal balance at any point during the draw period, which can actually decrease your overall costs in the repayment period.
2. Revisit your budget
In the time leading up to the start of your repayment period, reach out to your lender’s service department to review your total anticipated monthly payment, which may be significantly higher than your payments during the draw period which consisted of interest only.
If you have a fixed APR, your lender should be able to provide an estimated bill. If you have a variable APR, your lender should inform you of what your current rate is and what your new payment will be after the draw period ends, says Jamison.
Regardless, it’s a good idea to review your current budget and see if it is possible to set aside extra funds to help you prepare for this additional monthly payment. For example, consider reducing certain discretionary spending categories like dining out or entertainment and instead allocate those funds toward your scheduled payment.
3. Save for a potential balloon payment
Borrowers may be required to make one lump sum payment to pay off the remaining balance on the account, which can be financially devastating if you aren’t prepared. After revisiting your budget for any potential savings, consider supplementing your current income to help you save money quickly.
If your line of credit is structured this way and you are aware that you cannot make this payment in full, reach out to your lender as soon as possible to discuss alternative repayment options.
You can withdraw funds from your HELOC to help pay for costly home repairs or unexpected emergencies during the draw period, which lasts for a set amount of time. Typically borrowers are only expected to pay the interest on the amount borrowed during this phase, but once this period ends, your HELOC will transition into the repayment period.
It’s a good idea to proactively reach out to your lender to discuss your repayment terms and options before your repayment period begins so you can financially prepare yourself to begin paying back both the principal and interest on your HELOC.