With a home equity line of credit (HELOC), you can borrow against the equity in your home as a revolving line of credit. Unlike a home equity loan, which is disbursed in a lump sum and which you must begin repaying immediately, a HELOC works more like a credit card. You can borrow funds from a HELOC as you need them during the phase known as the draw period.
While many lenders typically require interest-only payments during the draw period, some lenders require principal and interest payments. However, once the draw period ends and the repayment period begins, you can no longer borrow from your HELOC and you must start repaying the principal balance owed.
Understanding what to expect from the end of the HELOC draw period can help you prepare for the sometimes abrupt transition to the repayment period. Here’s everything you need to know.
- With a home equity line of credit (HELOC), you can borrow against your home’s equity through a revolving line of credit during the draw period, which typically lasts 10 years.
- When the draw period ends, the HELOC goes into the repayment period, which may last up to 20 years. Terms may vary by lender, though.
- Some HELOCs require borrowers to repay the full amount owed as soon as the draw period ends, which is known as a balloon payment.
- In addition to making traditional payments, HELOC borrowers can prepay their loan during the draw period, convert it to a fixed-rate loan at the end of the draw period, or renew or refinance it.
What Is A HELOC Draw Period?
A HELOC has two different phases: a draw period and a repayment period. During the draw period, you can borrow money from your HELOC up to your line of credit at any time. Most HELOCs have a 10-year draw period, although some lenders offer shorter or longer draw periods.
Typically, lenders require interest-only payments during the draw period, although you usually are able to pay more than the minimum interest-only payment during the draw period. If you reach your credit limit on your HELOC during the draw period, you will need to repay some of the balance to borrow more money.
For example, let’s say you have a HELOC with a credit limit of $80,000 and a 10-year draw period. You borrow $55,000 to renovate your kitchen in the first year of your HELOC and make interest-only payments. Three years later, you borrow another $25,000 to put in a finished basement, maxing out your HELOC’s credit limit of $80,000.
In this scenario, you’ll typically continue making interest-only payments until the end of the draw period, but you can’t borrow any more from the HELOC. If you want to access more money from the HELOC, you will need to pay off some of the principal balance first.
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Can You Pay Off A HELOC During The Draw Period?
In most cases, borrowers can pay off a HELOC during the draw period. However, some lenders impose a prepayment penalty or other fee if you pay off the full balance before the end of the draw period.
Additionally, your lender may assume that you want to close the HELOC if you pay off your balance. If you’d like to keep your HELOC open for future borrowing but pay off the balance, you may need to double-check your loan’s terms and conditions and talk with your lender.
That said, paying off your balance – or at least paying what you can toward your principal balance – during the draw period means you pay less overall interest and could save you money in the long run.
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What Happens When The Draw Period Ends?
Once you have reached the end of the draw period, you can no longer borrow from your HELOC and the repayment period begins. During this phase, you must begin making payments to repay the principal balance.
Typically, a repayment period lasts 10 – 20 years, and you will make monthly payments over that time period to pay off the loan. However, in some cases, you may be required to repay the full balance owed as soon as the draw period ends. This kind of repayment is known as a balloon payment, and it can come as an unpleasant surprise to borrowers who aren’t prepared for it.
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What Are Your Repayment Period Options?
When your HELOC draw period ends and the repayment period begins, you generally have a few options for handling the loan: converting it to a fixed-rate loan, renewing it into a new HELOC or refinancing it into a home equity loan or cash-out mortgage refinance.
Here’s how each of these options works:
Convert Your HELOC Into A Fixed-Rate Loan
MostHELOCs have variable interest rates. Upon entering the repayment period, your monthly payments may change from month to month, depending on the variable interest rate.
However, some lenders will allow you to switch your balance from a variable-rate to a fixed-rate when your HELOC enters the repayment period. While the fixed interest rate will almost always be higher than the variable rate, having a predictable monthly payment can be an attractive proposition to borrowers.
Instead of a 10- – 20-year repayment period of unpredictable monthly payments, converting your HELOC to a fixed-rate loan allows you to determine your exact loan costs ahead of time.
Renew Your HELOC
As you reach the end of your draw period, you may be able to extend it by renewing your HELOC. To renew your HELOC, you will have to apply for a new HELOC with the same or a new lender and use the proceeds to pay off the old one. At that point, you may continue making interest-only payments during the extended draw period.
This can be a helpful option for any homeowner with a HELOC that has a balloon payment due when the draw period ends. In that scenario, you could renew the HELOC with the balloon payment, giving yourself another draw period. If your new HELOC allows, you could then immediately start to pay down the balance during the renewed draw period to ensure you don’t get overwhelmed by the repayment process.
Refinance Into A Home Equity Loan
If you have built more equity in your home since you took out your initial HELOC, a home equity loan is one way to refinance your HELOC.
A home equity loan is similar to a HELOC because they both allow you to borrow money against the equity in your home. The difference is that you receive the proceeds of a home equity loan as a lump sum and pay it back in installments. If you have enough equity in your home, you could refinance your HELOC by taking out a home equity loan to pay off the HELOC, then make monthly payments to the home equity loan.
This option may benefit a homeowner whose HELOC has a balloon payment due when the draw period ends, since it allows the borrower to spread out payments over a more manageable time frame. Home equity loans also are more likely to have fixed interest rates, which offers more predictable monthly payments.
But remember, you need to have built more equity than what is already tied up in your HELOC. For example, if your home is valued at $400,000, you owe $250,000 on your mortgage and you have a maxed-out HELOC with a credit limit of $80,000, your total home equity is only $70,000 because you owe a total of $330,000 ($250,000 on your mortgage and $80,000 on your HELOC).
Refinance With A Cash-Out Mortgage Refinance
Another HELOC refinancing option is a cash-out mortgage refinance. This strategy involves taking out a new mortgage equal to what you currently owe plus the balance of your HELOC, then using it to pay off both balances.
In the example above, your home is valued at $400,000 and you currently owe $20,000 on the mortgage and $80,000 on your HELOC. To do a cash-out mortgage refinance, you would take out a new mortgage for $330,000 that will pay off your old mortgage and your HELOC and give you a single monthly payment, usually with a fixed interest rate.
Typically, this refinancing strategy makes sense only if you can qualify for a better interest rate for the refinancing loan than you had for either your original mortgage or your HELOC. If the new interest rate is higher than either of those original loans, this strategy will probably not save you money.
However, if you can find a favorable interest rate, a cash-out mortgage refinance may be a good strategy for you if your HELOC has a balloon payment when the draw period ends and repayment begins.
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How Should I Prepare For The End Of My HELOC’s Draw Period?
Don’t let the end of the HELOC draw period take you by surprise. There are several important things you can do to be ready for the transition from the draw period to the repayment period of your HELOC, including:
- Figure out when the draw period ends.Start by determining how much time is left in your draw period. Check your lender website or your loan paperwork, or call your lender.
- Schedule a meeting with your lender, if possible. Before the end of the draw period, find out what you can expect from the repayment period for your HELOC. Will you have a balloon payment? Does your lender offer HELOC extensions? How much will your monthly payments be? It’s often easier to go over this kind of information directly with your lender.
- Consider making principal payments during the draw period. No matter how you plan to pay off your HELOC during the repayment period, you can generally lower your total cost by making some principal payments during the draw period. Find out if there is a prepayment penalty and decide if it’s worth it to lower your interest over time.
- Start the process for any new loan applications. If you are going to use any other kind of loan to pay off your HELOC or if your lender requires you to file an application to switch from a variable interest rate to a fixed rate at the end of the draw period, start the process now. Loan applications can take time, so starting this process in advance can ensure that you’re ready when the draw period ends.
The Bottom Line: Have A Strategy For The End Of Your HELOC’s Draw Period
The transition from a HELOC’s draw period to its repayment period can feel like a shock to your budget if you haven’t prepared for it. It’s important to plan ahead for the end of your HELOC’s draw period. That includes understanding what repayments your lender will expect and putting a plan in place for making payments, extending the HELOC or refinancing it with a new loan. With some careful planning, the end of a draw period doesn’t have to be an unpleasant surprise.
Ben Shapiro
Ben Shapiro is an award-winning financial analyst with nearly a decade of experience working in corporate finance in big banks, small-to-medium-size businesses, and mortgage finance. His expertise includes strategic application of macroeconomic analysis, financial data analysis, financial forecasting and strategic scenario planning. For the past four years, he has focused on the mortgage industry, applying economics to forecasting and strategic decision-making at Quicken Loans. Ben earned a bachelor’s degree in business with a minor in economics from California State University, Northridge, graduating cum laude and with honors. He also served as an officer in an allied military for five years, responsible for the welfare of 300 soldiers and eight direct reports before age 25.
