How Does HELOC Repayment Work?
Summary:
A home equity line of credit (HELOC) is a valuable financial tool that allows homeowners to tap into their home’s equity. And understanding how HELOC repayment works is essential for making an informed decision about the best way to access home equity. Today we’ll explore the key aspects of how HELOC repayment works, including when it enters the repayment period, strategies to reduce payments, and options for paying off a HELOC early.
A home equity line of credit (HELOC) offers homeowners a flexible way to access their home equity for financial needs such as paying off high-interest debt or making home improvements. It consists of two phases: the draw period, during which you borrow and make interest-only payments, and the repayment period, when you start repaying both principal and interest.
Keep reading while we delve into the details of a home equity line of credit repayment plan, both before and during the HELOC repayment period. First, let’s do a quick recap of what a home equity line of credit is and compare it to a home equity loan.
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What is a home equity line of credit?
A HELOC is a revolving line of credit, much like a credit card, where you can withdraw money as often as you like, up to your credit limit, within a specified draw period. The normal draw period is usually five to 10 years. Once the draw period is up, you enter the repayment period that can last up to 20 years. In addition, with HELOCs, you only have to pay back the money you’ve used.
“The line of credit usually equates to the equity you have in your home and typically comes with a variable interest rate,” adds Vik Gupta, head of home equity at PNC bank.
“Compared to other types of loans, HELOCs typically offer lower interest rates, which can make repayment easier. The interest paid on these loans is often tax-deductible, providing an additional financial incentive.”
How does a HELOC compare to a home equity loan?
For comparison, you can also consider a home equity loan, which is another common way to tap into your home’s equity. The main differences are that home equity loan proceeds are disbursed in one lump sum and normally come with a fixed interest rate. This means your fixed monthly payments consist of both principal and interest payments, which you’ll start paying back immediately.
It’s important to note that neither way of accessing your home equity is necessarily better than the other. But it is important to understand the differences so you can make the best decision for your unique financial situation.
Pro Tip
A home equity line of credit might be the smarter choice if you don’t have a specific amount of money you need. On the other hand, a fixed interest rate and a fixed monthly payment may make a home equity loan more attractive for some.
How does HELOC repayment work?
Understanding how to repay your HELOC and what it means when it enters the repayment period is crucial for managing your finances effectively. Here’s how the process works:
The draw period
During the HELOC draw period, which, as mentioned, spans about five to ten years, you have the flexibility to borrow funds from your HELOC up to your approved credit limit. At this time, you can borrow as much or as little as you need. For example, if your HELOC limit is $20,000, you might use $10,000 in one year and $5,000 the next. During this phase, your monthly payment covers only the interest on the borrowed amount.
The HELOC repayment period
Once the draw period concludes, your line of credit closes, and you can no longer access funds from the HELOC. Now, the repayment period begins. Generally, you’ll have around 20 years to repay the outstanding balance.
However, it’s worth noting that some HELOCs require a balloon payment of the entire balance, along with accrued interest, when the draw period ends. Be sure to check the repayment terms of your contract before signing up.
Without a balloon payment, your monthly payment will significantly increase compared to the interest-only payments during the draw period. It’s important to budget for higher monthly payments because they fluctuate based on your variable rate, which is most common for equity lines of credit.
“HELOCs generally have variable interest rates. This means that the interest rate and, by extension, the monthly payments, may change — and go up — over time. However, a few lenders (including Achieve) are now offering a fixed-rate HELOC,” explains Kyle Enright, president of Achieve Lending.
Calculating HELOC payments
Your lender will calculate your monthly payments based on factors including your HELOC’s interest rate, borrowed amount, and whether you’re in the draw or repayment period. During the draw period, you only have to pay interest. Once the repayment phase begins, your monthly payments will include both principal and accrued interest, aimed at paying off the total borrowed amount within the agreed-upon term.
How can I reduce my HELOC payments?
Reducing your HELOC payments during the repayment phase can help ease your financial burden. Check out the following strategies to see if they make sense for you.
Make principal payments during draw period
If you can manage it, make payments toward the principal balance during the draw period. This practice lowers your payments during the repayment phase by reducing the outstanding balance. Review your HELOC terms to check if this option is available, and be aware of any prepayment penalties.
Convert to a fixed-rate loan
If you have a variable interest rate HELOC, ask your lender about the possibility of converting part or all of your outstanding balance into a fixed-rate loan. This provides stable, predictable payments throughout the repayment period.
Request a renewal of your HELOC
Certain HELOCs offer the option to renew your credit line when the draw period ends. This means you have to apply for a new HELOC to pay off the existing one and enter a new draw period. This way you can continue making interest-only payments.
Refinance
If your home has sufficient equity, you may want to consider refinancing your HELOC through a couple different methods.
- Home equity loan: You may be able to take out a home equity loan to pay off your HELOC. Similar to HELOCs, home equity loans use your home as collateral but come with fixed payments, which can be more budget-friendly.
- Cash-Out Refinance: A cash-out refinance involves swapping out your current mortgage for a new, larger one and using the extra funds to pay off the HELOC. This option is only a good idea if the new mortgage offers a lower interest rate than both your HELOC and your existing mortgage.
Consider a home equity investment
Another option to pay off your HELOC without incurring new debt, is to seek a home equity agreement (also known as a home equity investment).
“A home equity agreement (HEA), (is) a non-debt option to tap home equity. In exchange for a portion of their home’s future value, homeowners receive an upfront lump sum. They can buy back their equity any time during the HEA term (generally 10 years); that often occurs when they sell their home,” says Michael Micheletti, chief communications officer at Unlock Technologies.
Micheletti adds that because an HEA isn’t a loan agreement, there is no monthly payment to budget for. Plus, credit score and income requirements are usually much more flexible than for traditional loan products.
Pro Tip
“The HEA can be an excellent option for a homeowner who needs cash now, and does not want to, or can not, take on additional monthly payments that would come with a loan option.” — Michael Micheletti, Unlock Technologies
Can you pay off a HELOC early?
Paying off your HELOC early can save you money on interest, but it’s essential to understand your loan terms. Most HELOCs permit early repayment without penalties, but some may have specific fees for early closure. Check your loan documents to determine any applicable penalties and evaluate whether the potential interest savings outweigh the costs.
“You can usually pay off your HELOC without penalty. However many lenders have penalties for closing your line within the first 3-5 years. Always assess and review your agreement to ensure you understand the terms,” Gupta advises.
When paying off your HELOC early, you’ll need to communicate with your lender to ensure that the extra payments go toward the principal balance. By doing so, you could potentially pay off the entire HELOC during the draw period, resulting in a zero balance and loan closure. Or at least you can save on interest payments if you pay off the loan before the repayment period ends.
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FAQs
What is a HELOC?
A HELOC is a financial tool that allows homeowners to borrow against the equity in their homes. It extends a line of credit to borrowers, like a credit card, instead of providing a lump sum of money like other loan products.
How does the draw period work?
The draw period is the initial phase of a HELOC during which you can borrow money up to your credit limit and (usually) make interest-only payments. The draw period generally lasts from five to 10 years.
What happens during the HELOC repayment period?
The repayment period follows the draw period and requires borrowers to start repaying both principal and interest on the HELOC balance. You cannot borrow more money once the draw period is up.
How can I lower my HELOC payments?
Options for lowering HELOC payments include converting to a fixed-rate loan, renewing your credit line, or refinancing through a home equity loan or cash-out mortgage refinance.
Is it possible to pay off a HELOC early?
HELOCs usually allow for early repayment without penalties, but borrowers should review their loan terms and potential costs before doing so.
Key Takeaways
- HELOC repayment includes a “draw period” with interest-only payments and a “repayment period” where you pay both principal and interest payments.
- HELOCs typically come with variable interest rates, which can cause your monthly payments to fluctuate during the repayment phase.
- A few ways to reduce HELOC payments include making principal payments during the draw period, converting to a fixed-rate loan, or refinancing.
- If you choose to pay off your HELOC early, be aware of potential penalties and ensure extra payments are applied to the principal balance.
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