What is the draw period on a HELOC and how does it work?

A home equity line of creditor HELOC, is a loan that allows you to borrow against the equity in your home and unlock your equity in cash at a low interest rate. A HELOC is a revolving line of credit that works like a credit card, meaning you can continue to withdraw from it over time whenever you need additional funds, instead of receiving the loan as a lump sum. HELOCs have draw periods — the length of time you can use your line of credit — that range from five to 20 years, with 10 years being the typical draw period.

This makes a HELOC an attractive way to tap into the equity in your home as it gives you access to a large amount of funds over a long period of time. Your home equity is the difference between what you owe on your mortgage and what your house is worth. So, for example, if your home is worth $400,000 and your mortgage balance is $300,000, you have $100,000 of home equity that you can borrow using a HELOC.

To qualify for a HELOC, lenders want to see that you have at least 15% to 20% of the 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 rates (although you may qualify with a score as low as 620) and have a low debt balance overall. HELOCs are secured by your home, which means your property could be repossessed if you miss payments or fail to repay your loan. Most Homeowners Use HELOCs for Major Living Expenses like home renovations, high interest rate debt consolidation or pay recurring fees like tuition.

Here’s what you need to know about HELOC drawdown periods, how they work, and alternatives to a HELOC if it’s not the type of funding for your personal financial situation.

What is a HELOC Draw Period?

A HELOC drawdown period is simply the period during which you are allowed to withdraw money from your open line of credit. At the end of the drawdown period, your line of credit closes and you can no longer withdraw funds. After your drawdown period closes – say, for example, after 10 years – the next stage of your HELOC is called the payback period, which typically lasts 20 years. This is when you must repay interest plus principal, but cannot borrow additional funds.

Keep in mind that while your HELOC drawdown period will never change, HELOCs have variable interest rates, so your rate will go up and down depending on what happens with interest rate trends. and the economy in general, which means you should have enough wiggle room in your budget to handle monthly payments that will likely rise and fall over time.

How do HELOC draw periods work?

During the draw period, you can continuously access your funds as needed. You do not need to take your loan as a lump sum. If, for example, you have a HELOC of $100,000, during your draw period you can withdraw $15,000, then six months later withdraw another $15,000, and so on. Your lender may have minimum amounts required for withdrawals, so make sure you understand all the terms of your loan before committing 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 can access cash for a decade, but only make small payments on a large balance. The amount of your monthly payments will vary depending on the amount of your loan and the interest rate. You can use a HELOC calculator to determine how much of a payment you can afford.

This is also where HELOCs can be tricky: once you’ve enjoyed the low payouts during your drawdown period, you may be in sticker shock when your repayment period begins and need to start paying back as well. the balance of your principal loan. Be prepared for your payments to increase significantly if you only made interest payments during the drawdown period – and for those larger payments to rise and fall as interest rates rise and decrease according to the evolution of the economy.

Your lender will have their own requirements for terms such as minimum withdrawal amounts, maximum number of withdrawals, and whether you qualify for a lower introductory interest rate. Make sure you understand the agreement you are making with your lender and what they allow you to do or not do with your money.

Once your draw period ends, your redemption period begins. This period is generally 20 years, but varies between lenders. Once the repayment period begins, you cannot borrow any more money; you can only pay it back.

How do you access your HELOC funds?

Most lenders and banks will offer you an online option to sign in and manage your account, as well as a physical credit card or checks to spend your funds. You should regularly monitor your HELOC balance and payments. If you can pay more than the required interest payments each month during your drawdown period, it will reduce your balance faster and minimize the amount of interest you pay over time. It’s a good idea to stay on top of your overall credit because your HELOC is an open line of credit that you’ll keep a balance on for years. To be on top of your credit now, take advantage of signing up for free weekly credit reports through the end of this year.

What happens when a HELOC draw period ends?

You can’t spend any more money after your drawdown period ends, except for paying off your HELOC in full (in which case you can start withdrawing back to your limit if your lender offers that option). Once your drawdown period ends, your repayment begins and you can only continue to repay what you have borrowed, not borrow more. Your repayment period will generally be 20 years, but the time frame will also vary from lender to lender.

A key difference during the payback period is that unlike the drawdown period – where your minimum payments are based on the amount you have withdrawn (not your total line of credit), your payments during the payback period are based on your total loan amount (the principal) plus interest. So don’t be shocked when you see a big increase in your monthly production. Make sure you can comfortably afford your increased payment on top of your regular monthly mortgage payment.

What other payment options can a homeowner consider?

If a HELOC is not the right type of loan for your personal situation, consider other types of financing. There are pros and cons to all types of financing, but interest rates should always be your primary consideration when considering the best option for your specific needs.

Home Equity Loans: These types of loans are also secured by your home, but you receive the loan upfront as a lump sum cash at a fixed interest rate. This means that you will have regular, fixed monthly payments instead of variable payments. You cannot continually withdraw from a home equity loan like you can with a HELOC, and you must make payments on the full loan amount since the start of your loan term.

Set the interest rate: It is possible to obtain a constant interest rate on your loan. “Ask your current HELOC lender if they will set the interest rate on your outstanding balance,” said Greg McBride, chief financial analyst at CNET’s sister site Bankrate. “Some lenders offer that, many don’t.”

Refinance your HELOC: You can convert your HELOC into a home equity loan. “If fixing the interest rate isn’t an option, you might consider refinancing your HELOC into a fixed rate home 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. .

Refinancing by collection: A cash refinance also provides you with a lump sum of cash, but it’s cost-effective and replaces your current mortgage with a new mortgage, so you only have to make one monthly mortgage payment, instead of two. . This option may not be feasible for most homeowners in today’s rising interest rate environment, as your refinance rate generally 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 these unsecured financing options.

The bottom line

HELOC draw periods last for years (ranging from five to 20 years, but typically 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 a HELOC if you decide to go this route for financing. As always, shop around and compare offers from lenders to get the best rate and term available to you. Even 1/10 of a percentage point can make a huge difference in the amount of interest you pay over the life of a loan, especially a large variable rate loan such as a HELOC.

Maria D. Ervin