What To Know Before Your HELOC Draw Period Ends
When taking out a home equity line of credit (HELOC), the HELOC draw period is your chance to spend the money you’ve been approved to borrow against your home equity. Similar to a credit card, you just spend what you need up to a set limit and make minimum payments until your draw period ends.
It’s important to keep in mind, though, that you can’t access the credit line anymore once the draw period is over, and you’ll have to start making much larger payments. Here’s what you need to know before your HELOC draw period ends.
What is a HELOC draw period?
A HELOC has two phases: the draw period and the repayment period. One is for spending the money and one is for paying it back. What you ultimately need to know before the draw period ends is how you plan to repay the credit line. Depending on your personal repayment strategy, there may be actions you need to take before the draw period ends.
Let’s say you took out a HELOC to pay for a home improvement project, like finishing your basement; the draw period is the window of time during which you’re buying tools, paint and other supplies. Most of the time, your lender will give you a credit card or special checks you can use to spend the money. They’ll also set your credit limit, or the maximum amount you can borrow, based on how much home equity you have.
Equity is the difference between how much you owe on your property and what it’s worth. With a HELOC, you likely won’t be able to borrow more than 85% of your home value.
Your draw period is a set number of years, often 10 years. During that time you’ll have to make minimum interest payments, but in most cases you won’t have to pay down the principal balance. This typically means relatively low payments that vary based on how much you’ve borrowed, just like with a credit card.
At the end of the draw period, you may be able to renew your line of credit and restart the clock. Otherwise, you’ll enter the repayment period.
How does HELOC repayment work?
Once the repayment period hits, you’re no longer able to spend any more of the money and you’re required to start paying back everything you’ve borrowed, with interest. Now that the days of interest-only payments are over, expect your monthly payments to jump up significantly — especially if you didn’t pay down the principal balance at all during your draw period.
Your repayment period will generally be a set number of years, typically 10 to 20. Most HELOCs have variable interest rates, so your monthly payment may change over the course of your repayment period. This is different from a standard mortgage or home equity loan, both of which you immediately start paying back with a fixed interest rate, meaning your monthly payments don’t change.
Some HELOCs require you to pay what you owe immediately when the draw period ends. This is called a balloon payment.
HELOC repayment example
To return to our earlier example, let’s say that your basement renovation is now long finished. In total you spent $25,000 on materials, and you chose a fixed-rate HELOC with a 6% interest rate. You’ve since hosted half-a-dozen Super Bowl parties in the space, but during that time you didn’t pay more than the minimum (interest-only) payments. Here’s what your payments would look like in both the draw and repayment periods:
|Draw period||Repayment period|
|Time period||Years one through 10||Years 11 through 20|
As you can see, your monthly payment would more than double once the draw period ended.
HELOC payoff options for before the draw period ends
When you’re taking out a HELOC, you’ll usually have many different options for paying it back. Here are a few that require you to take action before the draw period ends.
1. Make the minimum payments
It’s OK to make the minimum payments during the draw period as long as you’re keeping tabs on when the draw period ends and what your payments might look like once it does. It’s not uncommon for monthly payments to more than double once the repayment period hits.
2. Pay more than the minimum payment during the draw period
During the draw period, you often only need to make interest payments on the amount you borrow. However, you’ll generally have the option to pay down the principal balance as well — this can help ease any whiplash you might feel when you enter the repayment period.
Watch out for prepayment penalties>
It can pay to double-check your loan paperwork for prepayment penalties, which some HELOCs have. These are usually a fee charged when you pay off the credit line in full, but in some cases can apply to making more than your scheduled payment.
3. Convert to a fixed-rate loan
HELOCs usually have variable interest rates, but some lenders will allow you choose a fixed-rate option or convert some or all of an existing HELOC balance to a fixed-rate loan. This has the advantage of locking in your monthly payment, so you don’t have to worry about it rising over time. Keep in mind, however, that lenders usually require you to convert to a fixed-rate option before the end of the draw period.
HELOC payoff options after the draw period ends
1. Make the standard payments
Once you enter the repayment period, unless you’re facing a balloon payment, the loan will become fully amortizing. What that means is that the lender will create a monthly principal and interest payment plan that will fully pay off the loan by the time it’s over. HELOCs traditionally come with variable interest rates, so your payments will change with the market.
2. Renew or refinance to another HELOC
At the end of the draw period, you may be able to renew your HELOC. This can save you from having to take out a new loan if you know that you plan to borrow more in the future. You’ll then re-enter the draw period and restart the clock.
3. Refinance to a home equity loan
Another option is to use a home equity loan to pay off your outstanding HELOC balance. Home equity loan rates are typically higher than HELOC rates, but this option could make sense if you prefer a loan with a fixed rate and predictable payments.
4. Use a cash-out refinance
If you want to refinance your first mortgage, you can use a cash-out refinance to pay off your HELOC at the same time. However, if you use the refinance to pay off some — but not all — of the HELOC, you’ll have to pay extra fees or higher interest rates on that new first mortgage. The fees will depend on the combined-loan-to-value (CLTV) ratio of both loans.
Conventional cash-out refinance rate changes for 2023>
Beginning May 1, 2023, conventional cash-out refinances are getting more expensive. Expect to potentially see higher interest rates or an extra fee at closing if you’re taking cash out and borrowing more than 30% of your home’s value. The fee will range from 0.375% to 5.125% of your loan amount, depending on your credit score and LTV.
5. Make a balloon payment
Some HELOCs require a balloon payment at the end of the draw period. Because it will pay off the full amount, a balloon payment could be as large as tens of thousands of dollars and is usually more than twice your average monthly payments. Be sure to check if your HELOC requires a balloon payment before agreeing to it, since these can often cause problems for borrowers. Don’t count on being able to refinance out of a balloon payment.
You may also choose to do this on your own by voluntarily paying off the loan with a lump sum at any time. Just be aware that some HELOCs charge a penalty if you completely pay off the loan ahead of schedule.