If you’re considering opening a HELOC, understand how you will pay it back. Learn how HELOCs work, how payments are calculated, how to pay them back, and more.
How HELOCs Work
Every HELOC is broken into two phases: the draw period and the repayment period. During the draw period of your HELOC, you can borrow up to the credit limit for any purpose. Like with a credit card, you can spend on your line of credit again after you repay the balance. The draw period on your HELOC may vary by lender, but they often last for about 10 years. Once the draw period on your HELOC ends, you’ll enter into the repayment period. During this time, you can no longer borrow against your HELOC. You’ll make minimum monthly payments until the borrowed amount is repaid, just like any other loan. The repayment period of the HELOC varies by lender and is typically about 10 to 20 years.
What’s Included in a HELOC Payment?
Like other loans, your HELOC payment includes two components: principal and interest. The principal is the amount of the HELOC that you’ve used. The interest is the additional money you pay to borrow the funds. HELOCs usually have variable interest rates, meaning the rate can change over time and is based on a particular rate index. As market rates increase, the rate on your HELOC—and, therefore, your monthly payments—increase as well. On the other hand, as market rates decrease, your interest rate and payments may also decrease. Whether you’re in your draw period or repayment period will affect what is included in your HELOC payment.
How To Calculate HELOC Payments
The amount of your HELOC payments depends on whether you’re in the draw period or the repayment period. Let’s look in more detail at how payments are calculated during the different phases of your line of credit.
Draw Period
During the draw period of your HELOC, you’ll have a variable interest rate and a payment based on the amount you’ve used from your credit line. The repayment terms will depend on your lender. Some may require you to pay accrued interest and a percentage of your principal balance, similar to a credit card. In many cases, the minimum payments during your draw period won’t be enough to repay the loan. In fact, some lenders only require interest payments during the draw period. However, the principal balance will accrue interest during that time, and if your principal increases, so will your interest payments. You can pay off the principal during the draw period, even though you aren’t required to. Some borrowers may prefer to pay off the full HELOC as soon as possible so they can use it again during the draw period.
Repayment Period
In the repayment period, you’ll no longer be able to borrow from the line of credit. Instead, the focus turns to repaying what you’ve borrowed, along with interest. Some lenders require a balloon payment at the end of the draw period, at which point, you’ll have to repay the entire outstanding balance. However, most lenders have an extended repayment period, during which time you’ll repay your HELOC like you would a loan. Your payments during the repayment period are amortized and based on your principal and interest. The amount you’ll pay will include your accrued interest as well as enough of the principal balance to have your entire line of credit paid off before the end of the repayment period. It’s also important to note that if you sell your home during either your draw period or repayment period, you’ll likely have to repay your full balance immediately. Remember, your HELOC is secured by your home. If you no longer own the asset securing the debt, the lender will probably want their money back.
How To Pay Off a HELOC
When you get to the repayment period of your HELOC, you’ll usually have two options: You can choose to repay the balance, or you can refinance to change the payment terms.
Make Your Monthly Payments
The most straightforward way to deal with your HELOC repayment period is to simply repay the loan. You can repay it right away or based on the schedule your lender has set. Because of the variable rate, your payments could increase or even become unaffordable, which may require you to consider refinancing.
Refinance
When your HELOC draw period ends, you could refinance several different ways. They include:
Refinancing into a new HELOC with a new draw period, and possibly interest-only payments Refinance with a fixed-rate HELOC Refinance with a home equity loan, which is a term loan that often has a fixed interest rate and fixed monthly payments Refinance into your mortgage, which would require taking out a new mortgage to pay off your existing mortgage and HELOC
The Bottom Line
A HELOC can be an excellent tool to help you pay for home repairs or renovations, consolidate high-interest debt, send a child to college, and more. But they also have some risks, including the variable interest rate and the fact that your credit line is secured by your home. As with any other type of debt, it’s important to understand the terms of your HELOC before finalizing the agreement. Make sure you’re well-versed on your HELOC’s credit limit, repayment terms, interest rate, and more. Want to read more content like this? Sign up for The Balance’s newsletter for daily insights, analysis, and financial tips, all delivered straight to your inbox every morning!
