ANDor HELOC, is a loan that allows you to borrow against your home equity and unlock your equity in cash . A HELOC is a revolving line of credit that works like a credit card, meaning you can draw on it over time whenever you need additional funds, instead of receiving the loan as a lump sum. HELOCs have drawdown periods—the length of time you can draw on your line of credit—ranging from five to 20 years, with 10 years being a typical drawdown period.
This makes HELOCs appealingbecause it gives you access to large amounts of funds over a long period of time. Yours is the difference between what you owe on your mortgage and what your home is worth. So, for example, if your home is worth $400,000 and your mortgage balance is $300,000, you have $100,000 of equity in your home that you can borrow against with a HELOC.
To qualify for a HELOC, lenders want to see that you have at least 15% to 20% equity in your home (you can usually borrow up to 85%) as well as a good credit score of 700 or higher to secure the best rate (although you can qualify scores of up to 620) and overall show a low debt balance. HELOCs are secured by your home, which means your property can be repossessed if you miss payments or default on the loan. Most homeowners use HELOCs for major living expenses, or paying recurring costs such as college tuition.
Here’s what you need to know about HELOC drawdown periods, how they work, and alternatives to HELOCs if it’s not the type of financing for your personal financial situation.
What is a HELOC draw period?
A HELOC drawdown period is simply the period of time you can withdraw money from your open line of credit. At the end of the drawing period, your line of credit is closed and you cannot withdraw any further funds. After the drawdown period ends—say, after 10 years—the next phase of your HELOC is called the repayment period, which typically lasts 20 years. Then you have to pay back the interest plus the principal, but you can’t borrow any more funds.
Keep in mind that even though your HELOC draw period never changes, HELOCs have variable interest rates, so your rate will go up and down depending on what happens with interest rate trends and the economy overall, which means you should have enough room to breathe. budget to manage monthly payments that are likely to rise and fall over time.
How do HELOC draw periods work?
During the withdrawal period, you can continuously access your funds as needed. You don’t have to take out a one-time loan. For example, if you have a $100,000 HELOC, you can withdraw $15,000 during the draw period and $15,000 six months later, and so on. Your lender may have minimum withdrawal requirements, so make sure you understand the full terms of your loan before you commit to it.
One of the biggest benefits of a HELOC is that you can make interest-only payments during the drawdown period, which keeps your payments low in the beginning. This means you have access to cash for ten years, but only minimum payments on the large balance. The amount of your monthly payments will vary depending on the amount of the loan and the interest rate. Use a HELOC calculator to find out how much of a payment you can afford.
Here’s where HELOCs can get tricky, too: Once you enjoy low payments during the drawdown period, you may be in for sticker shock when your repayment period begins and you have to start paying off the principal balance of the loan as well. Be prepared for your payments to go up significantly if you’ve only been paying interest during the drawing period — and for those larger payments to rise and fall as interest rates rise and fall depending on what’s happening with the economy.
Your lender will have their own terms and conditions requirements, such as minimum withdrawal amounts, maximum number of withdrawals and whether you qualify for a lower introductory interest rate. Make sure you understand the contract you’re entering into with your lender and what it allows you to – and doesn’t allow – you to do with your money.
Once your drawing period ends, your repayment period begins. This period is usually 20 years but will vary between lenders. Once the repayment period begins, you cannot borrow any more money; you can only repay it.
How do you access your HELOC funds?
Most lenders and banks will offer you an online option to sign up and manage your account, as well as a physical credit card or checks to spend your funds. You should monitor your HELOC balance and payments regularly. If you can pay more than the required interest-only payments each month during the draw period, it will reduce your balance faster and minimize the amount of interest you pay over time. It’s good to have an overall view of your credit because your HELOC is an open line of credit that you’ll have a balance on for years. To get your credit on top now, take advantage of the free weekly credit report subscription until the end of this year.
What happens when the HELOC draw period ends?
Once your drawing period comes to an end, you can’t spend any more money except to pay off your HELOC in full (in which case you can start drawing on it again up to your limit if your lender offers that option). Once your drawdown period ends, your repayments begin and you can continue to pay back only what you borrowed – not borrow more. Your repayment term will usually be 20 years, but the time frame will also vary from provider to provider.
The key difference during a repayment period is that, unlike a drawdown period – when your minimum payments are based on the amount you’ve withdrawn (not your total credit limit), your payments during a repayment period are based on the total amount. of your loan (principal) plus interest. So don’t be shocked if you see a significant increase in monthly performance. Make sure you can comfortably afford the increased payment on top of your regular monthly mortgage payment.
What alternative payment options can a homeowner consider?
If a HELOC isn’t the right type of loan for your personal situation, consider other types of financing. All types of financing have their pros and cons, but interest rates should always come first when considering the best option for your particular needs.
Home equity loans: These types of loans are also secured by your home, but you receive the loan upfront as a lump sum of cash with a fixed interest rate. This means you will have consistent, fixed monthly payments instead of variable ones. You can’t keep withdrawing from a home equity loan like you can with a HELOC and you have to pay the total amount of the loan from the beginning of your loan term.
Fix the interest rate: It is possible to secure a fixed interest rate for the loan. “Ask your current HELOC lender if they will fix the interest rate on your balance,” said Greg McBride, chief financial analyst at Bankrate, a CNET sister site. “Some lenders offer it, many don’t.”
Refinance your HELOC: You can convert your HELOC to a home equity loan. “If a fixed interest rate isn’t an option, you can look into refinancing your HELOC to a fixed-rate loan,” McBride said. “The rate may not be much different than what you’re currently paying on your HELOC, but it provides certainty about your interest rate, monthly payment and payback period,” he added.
Payout refinancing: A payday refinance also gives you a lump sum of cash, but it pays off and replaces your current mortgage with a new mortgage so you only have to pay one mortgage instead of two monthly payments. This option may not be feasible for most homeowners in today’s rising interest rate environment, as your refinance rate typically needs to be lower than your current mortgage rate for refinancing to make financial sense.
Personal loans and credit cards: These types of financing do not require you to put your home as collateral as they are unsecured loans. Expect to pay higher interest rates for such unsecured financing options.
The drawdown period for a HELOC is years (ranging from 5 to 20 years, but usually 10 years), giving you access to an open line of credit at a low interest rate for an extended period of time. Before you sign on the dotted line, make sure you understand the risks of using your home as collateral to secure andif you decide to go down this financing route. As always, shop around and compare offers from lenders to ensure you get the best rate and term available to you. Even 1/10th of a percentage point can make a huge difference in the amount of interest you pay over the life of the loan, especially on a large variable rate loan like a HELOC.