You need cash to fix your leaky roof. Or, you want to replace your dated cabinets with chic, soft-close ones. Whatever the case may be, home equity lines of credit (HELOCs) can give you access to a large revolving credit line that you can tap into over and over for a set amount of time, known as the draw period.
But what happens when the HELOC draw period ends?
Your draw period can be as long as 10 years, so entering into repayment — with full interest and principal payments — can come as a major surprise. “It can be a switch,” says Katie Bossler, Quality Assurance Specialist at GreenPath Financial Wellness, a national nonprofit financial counseling agency. “It’s kind of like having a credit card that’s no longer available for use,” she adds.
If you don’t have a plan in place for managing your payments when the draw period ends, you could be left scrambling to cover the cost. And since your home serves as collateral on the HELOC, it could be a risky situation.
To prevent any issues once your repayment begins, take the time now to review your HELOC agreement, understand your payment options and develop a plan to tackle your debt.
How a HELOC Works
“As a line of credit, you can use it repeatedly and make draws to meet your needs,” says Jon Giles, senior vice president and head of consumer direct lending at TD Bank. “Instead of borrowing everything on day one, you can withdraw funds as you need them,” he explains.
It’s this flexibility that makes HELOCs appealing for borrowers, but it also comes with its own risks. The fact that you can borrow continuously against the credit line throughout the entire draw period, coupled with the fact that the interest rate can change over time, means you may not know what your monthly payment will be until repayment begins. This makes it especially important to plan ahead.
What Is a HELOC Draw Period
While HELOC terms can vary based on the bank issuing the line of credit, they all follow this basic structure: you have a draw period, followed by a repayment period.
The draw period is the predetermined length of time you can use your revolving line of credit. During the draw period, you can withdraw from your HELOC account to pay for any expenses you may have.
While you’re in the draw period, you might only be required to make interest-only payments. Depending on your loan terms, interest rate, and the amount of available credit, your payment during the draw period can be quite low.
Each lender will have its own terms, but the most common length for draw periods is 10 years. “I stress that people speak with their bank,” says Giles. “Different banks have different policies and structures. But generally, HELOCs have a 10-year draw period, followed by a 20-year repayment period,” he says.
What Is a HELOC Repayment Period
Once your draw period ends, your HELOC will enter repayment, and you’ll no longer be able to tap into the line of credit.
During the draw period, you were only required to make payments against the interest. Once you enter into the HELOC repayment period, you’ll have to make full amortized payments, meaning you’ll pay against the principal and interest.
After several years of making interest-only payments, the jump to full interest and principal payments can come as a shock, so make sure you review your loan documents and make note of when your HELOC will enter repayment. “Be prepared to make that full payment when the loan converts to a fully amortized payment schedule,” says Tabitha Mazzara, director of operations with the Mortgage Bank of California (MBANC).
It’s important to know that you don’t have to wait for the repayment period to start making payments. In fact, experts recommend making regular payments towards the principal during the draw period to reduce the burden during the repayment period. Not only will that help you lower your monthly payment later on, you’ll also save on interest overall. “I would encourage somebody to think about a plan even before their repayment period starts, to get [the HELOC] paid off,” says Bossler.
HELOC repayment terms vary but can be as long as 20 years. “Repayment periods are completely dependent on the lender,” says Mazzara. “I’ve seen 20-year lines, 15-year lines, five-year lines. I’d say the average is about 15 years,” she says.
Unlike some other forms of credit, such as personal loans or home equity loans, most HELOCs have variable interest rates. The rate is based on the Prime Rate — the baseline rate banks charge their most credit-worthy customers, which can fluctuate over time — plus the lender’s margin. Because the HELOC has a variable rate, your payment can change from month to month as the interest rate increases or decreases.
What to Do Before Your Draw Period Ends
If you took out a HELOC and your draw period end date is approaching, here are some things you can do now to ensure you transition smoothly into repayment:
Contact Your Bank
As your draw period comes to an end, your bank will send you letters reminding you about your repayment terms. “We’re all guilty of not opening every piece of mail, but pay attention to anything coming from your bank,” suggests Giles.
If there’s a chance you’ve missed the notification, call or visit your bank in person to review the HELOC terms and get answers to any questions you may have. The bank can tell you when the draw period will end, when your repayment term begins, and how much your first payment will be.
Check the Interest Rate
In most cases, HELOCs have variable interest rates. However, there may be an opportunity to transfer it to a fixed interest rate. “Most banks will have a fixed-rate option for repayment as part of the HELOC, but you may need to set that up prior to the end of the draw period,” says Giles. “Contact your bank and ask,” he recommends.
If you’re worried about the variable interest rate on your HELOC, talk to your bank about refinancing your line of credit into a home equity loan. While both HELOCs and home equity loans are secured by your home, a home equity loan typically has a fixed interest rate and fixed monthly payment, which can be easier to budget for.
A fixed interest rate can be a good idea if you think you’ll need the entire repayment period to pay off the HELOC. It will give you predictable monthly payments so you can budget accordingly. However, a variable interest rate may be better for some borrowers. “It may make sense to keep it [the interest rate] variable if you want to pay it off faster since you can take advantage of the low rates right now,” says Giles.
Ask About Balloon Payments
With some HELOCs, paying the minimum required each month won’t pay off the line of credit by the end of your repayment term. For those HELOCs, the bank may require a balloon payment. Balloon payments are larger, lump-sum payments that cover the remaining balance, so you may have to come up with thousands of dollars at once to eliminate your debt.
If you aren’t sure if a balloon payment is required, contact your bank and ask about your HELOC’s terms.
Look for Fees and Penalties
If you want to repay a HELOC quickly, keep in mind that there may be additional fees for paying off a HELOC early. While many HELOC lenders don’t charge prepayment penalties, there are some that do. Review your HELOC agreement and term disclosure documents to see if there are any prepayment or early closure fees.
Update Your Budget
Beyond the fact that you’ll need to make monthly payments towards the debt, Bossler says there’s another factor that people sometimes forget about the repayment period: the fact that you’ll no longer be able to borrow money. Before your HELOC draw period ends, make sure that you not only adjust to the upcoming monthly payments, but also figure out how you’re going to pay for things that you were previously using the HELOC for, she advises. Consider setting up an emergency fund for when you can no longer use the HELOC to cover unexpected expenses, or trim some expenses from your monthly budget to prepare for that decrease in cash flow.
Alternative Repayment Options
When the HELOC draw period ends, you will enter into the repayment period and make payments under the agreed-upon terms. However, you could use the following alternatives to save money or change your repayment schedule:
- Make Payments Toward the Principal During the Draw Period: If you can afford to do so, consider making payments toward the principal during your draw period instead of making interest-only payments. By chipping away at the principal sooner, less interest will accrue, and you’ll get out of debt faster.
- Pay More Than the Minimum Required: Paying only the minimum will ensure you’re in debt for the full HELOC repayment term, and you may still have to make a balloon payment at the end of it. To pay off the HELOC quickly, pay more than the minimum required. Even a small extra payment — such as $50 per month — can make a significant difference.
- Refinance to a New HELOC: As your draw period ends, you may find that you still need access to a line of credit, or you may need more time before you can make amortized payments. If that’s the case, you could refinance your line of credit into a new HELOC. “Interest rates are advantageous right now,” says Giles. Because of this, you may be able to get similar or better rates than your original HELOC. But be aware of the pros and cons of taking on new debt. “Think about what you are trying to do with the monthly payment, how quickly do you want to pay this down, and decide if you still need a line of credit,” Giles advises.
- Convert to a Fixed Interest Rate: If you think you’ll take several years to pay off the HELOC and would like a predictable, fixed monthly payment, talk to your bank to find out if there is a fixed-rate repayment option available.
- Speak with a credit counselor: If your HELOC repayment period is coming up but you’re struggling to pay off the debt, consider seeking free or low-cost help from a non-profit credit counseling service. A credit counselor can look over your budget, help you determine an affordable debt payoff plan, and figure out the best strategy to meet your financial goals, says Bossler.