What to Know Before Your HELOC Draw Period Ends
One of the biggest perks of a home equity line of credit is the flexibility. Like a credit card, you can borrow as little or as much as you need, up to a certain limit, and as you repay your outstanding balance, you replenish your amount of available credit. Plus, you only pay interest on what you use.
But unlike a credit card or an installment loan, a HELOC has two distinct phases: the draw period and the repayment period. During the draw period, you can pull from the line of credit any time, and you typically make interest-only payments on what you’ve borrowed.
Then, after a set time period, your repayment period begins. Once this starts, you can no longer borrow money and you must begin repaying principal along with interest, resulting in a larger payment. If you aren’t able to make your payments, you run the risk of losing your home.
If you have a HELOC or are thinking about getting one, here’s what you need to know as your draw period winds down so you can financially prepare for your repayment period.
Know when your repayment period begins
When you took out your line of credit, you agreed to the time frame for each period. While they vary by lender, the draw period is typically around 10 years, and the repayment period is often 15 to 20 years. However, depending on your HELOC, the repayment period could be longer.
That sounds like plenty of time, but consumers who don’t prepare for their draw period to end and only pay the minimum amount during that time can find themselves in trouble.
“HELOCs can be a great financial tool if used wisely, but if not paid off or paid down during the draw period, they could be dangerous for those who haven’t planned for it,” said Steven A. Boorstein, a CFP and founder of RockCrest Financial in Williamstown, N.J.
While the minimum payments during the draw period typically only cover interest, borrowers can choose to pay more than the minimum to start knocking out some of the principal. (Though some lenders offer HELOCs that have you repay both interest and principal during the draw period, which keeps your payments more consistent throughout draw and repayment.)
Those who don’t make more than the minimum payment may be surprised by how much their monthly payment increases when the draw period ends.
“You will now be responsible for paying both principal and interest each month, so plan accordingly and don’t get caught off guard by the larger payment amount,” said Eric Aved, senior vice president and home equity product executive at Bank of America.
Because of this increase in monthly payment, it’s vital to know when your repayment period begins so you can prepare your budget for the higher expense. Look at your loan documents to find out when that period begins, or ask your lender if you’re unsure.
Determine how much you owe
Part of preparing for the higher payment requires figuring out how much you will owe during the repayment period. If you only ever paid interest on your HELOC during the draw period, you have to repay the full balance during the repayment period, plus the rest of the interest.
“It’s important to understand which type of HELOC financing you have,” Aved said, because “this will determine your repayment method once you reach the end of draw.”
Common HELOC repayment plans
Standard: You make a monthly payment toward the principal balance and accrued interest until you repay the outstanding balance.
Balloon: At the end of your draw period, the entire HELOC balance becomes due in one, lump-sum payment, also called a balloon payment.
If you’re not prepared for that large payment, it could be financially devastating.
Call your lender and find out what your monthly payment will be once your repayment period begins, and make sure you know if there’s a balloon payment. Then, “take a look at your cash flow or budget, and make sure that you have planned for the principal and interest payments that you’ll have to make during the repayment period,” Boorstein said.
Explore your repayment options
Are you getting nervous that you won’t be able to pay your loan back in full during the repayment period? Or do you want to keep a line of credit open? You have a few options besides simply repaying the HELOC as originally planned.
- Get a new HELOC: Some HELOCs can be renewed, or you could get a new HELOC with a different lender. “The new HELOC will be used to pay off the old one and will ‘reset’ your draw period so that the payments will go back to interest-only, so be smart and at least try to make some principal payments if you choose this route,” Boorstein said. He added that most lenders would lend on a HELOC only up to a certain percentage of the home’s current value. “If your home value has dropped since you received the first HELOC, and your primary mortgage and HELOC are now more than 85 to 100% of your home value, you may not be able to get a HELOC, or your interest rate or terms may not be as favorable,” he explained.
- Refinance your mortgage: “You can roll your mortgage and HELOC into a new first mortgage, which could potentially reduce your payments — but may also extend your loan by 30 years,” Boorstein said. You could also potentially get a cash-out refinance if you can get enough money to cover what you owe on the HELOC. Ask your lender if you could do this through them; if not, reach out to other lenders for quotes.
- Take out a home equity loan: You could apply for a home equity loan and use it to pay off your HELOC, and then you’ll be paying a fixed amount at a fixed rate.
- Seek help. If you’re concerned you’ll struggle to repay your HELOC during the repayment period, Boorstein suggested consulting with a homeownership counselor approved by the Department of Housing and Urban Development (HUD) or a financial planner. “If you don’t feel you have many options left and could potentially lose your home, contact your lender to see if they offer any loan modifications,” he said. Boorstein added that you could also look into federally-sponsored programs, such as the Home Affordable Refinance Program, which helps homeowners who have little to no equity in their homes. Note: HARP expires Dec. 31, 2018.
A home equity line of credit can be a useful way to tap your home’s equity and help you afford major expenses. But if you’re not prepared for your repayment period, it could land you in financial trouble or even put you at risk of losing your home, so make sure you know what’s required and what options are available to you.