Is your HELOC draw period ending soon? What experts say you should know now
The run-up in home prices in recent years, combined with factors such as inflation and high interest rates, have caused some homeowners to tap into their home equity. In many cases, borrowing from your home equity is less expensive than other options like credit cards or personal loans, but it's important to still be aware of the full costs and terms of financing.
One of the more popular ways to borrow from your home equity is with a home equity line of credit (HELOC), which typically lets you withdraw money on a revolving basis over a period of around five to 10 years. This timeframe is known as the draw period, during which you often just have to pay interest on the amount borrowed.
But when the draw period ends, you then typically face a repayment period that functions like a regular loan, where you repay the principal plus interest. And, experts say there are other things you should know about the end of your HELOC draw period, too.
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Is your HELOC draw period ending soon? What experts say you should know now
If you're coming to the end of your HELOC draw period soon or want to be prepared for when that happens down the line, here are some of the most important considerations:
Know the HELOC terms
First, you want to make sure that you're clear on the terms of your HELOC so that you can plan to pay it off accordingly, without making expensive mistakes.
"Transitioning from making interest-only payments to covering both principal and interest is a significant shift that can substantially increase monthly payments. It's vital to be aware of the exact date this transition occurs to ensure readiness for the financial adjustment," says Matt Dunbar, SVP of Southeast Region at Churchill Mortgage.
You also want to be aware of prepayment options, as you might not always have to wait until the draw period ends if you're looking to minimize interest charges.
"In most cases, during the draw period you can only make payments for the interest you've accrued — not for the actual loan principal. But that's not always the case," says Seamus Nally, CEO at TurboTenant. "Some lenders do allow you to also make payments toward the loan principal during the draw period, which can be very helpful in paying back the money more effectively."
"However if you aren't allowed to do this, then don't overlook that fact and try to prepay anyway, because you'll likely encounter penalties that will essentially nullify the goal of prepaying entirely," he adds.
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Be proactive about higher rates and payments
Because your monthly payments will often increase once the draw period ends, ideally you can prepare for that ahead of time.
"Have a plan," says Sarah Alvarez, vice president of mortgage banking at William Raveis Mortgage. "You want to have the drawn amount paid down to a place where you will be comfortable with the payments once they jump and become amortizing to pay the balance off over the remaining term of the loan."
Also, HELOC interest rates tend to fluctuate, so it's important to realize that the rate you initially got when opening the HELOC is not necessarily what you're paying now or what you'll pay when the draw period ends.
"Because most HELOCs have variable interest rates, that does mean that you might have a higher interest rate now than you did when first opening the HELOC, so your payments are likely higher. Ideally, you should be aware of those increases as they happen and that should allow you to strategize ways to put any necessary additional money aside for your payments," says Nally.
Consider alternative repayment options
If you're not in a position to handle higher payments once the draw period ends, then you might want to consider alternative ways to manage your debt.
"Evaluating one's financial stability to accommodate potentially higher payments or exploring options like loan restructuring are essential steps as the repayment phase begins," says Dunbar.
For example, in a high-interest rate environment, you might consider options like "refinancing the line of credit to a fixed-rate loan to secure more predictable monthly payments," he adds. "Consolidating the HELOC with other debts into a single loan with a lower interest rate can also be a prudent approach, potentially reducing overall interest costs and simplifying monthly payments."
Talk to your lender too so that you can see what options they can make available to you.
"Communication with the current lender about modifying loan terms can uncover potential adjustments that better align with changing financial circumstances, offering a smoother transition as the repayment phase commences," says Dunbar.
It's also possible that a cash-out refinance works to your advantage, enabling you to pay off the HELOC with the cash from the refinancing.
If you can wind up with a lower monthly payment doing that rather than having a mortgage plus a HELOC repayment, then "you may end up having to let go of a great rate on a first mortgage by doing a refinance to get rid of the balance," says Alvarez.
The bottom line
When a HELOC draw period ends, you could face higher payments, so it's important to prepare in advance. Knowing the specific HELOC terms, along with making a financial plan and considering other financing options if needed can go a long way toward making your repayment period easier.
