Do You Only Pay Interest on a HELOC?

A Home Equity Line of Credit (HELOC) allows homeowners to borrow against their property’s equity, functioning as a revolving line of credit with a predetermined limit. Like a credit card, it provides access to funds, but is secured by your home. Understanding HELOC obligations involves more than just the interest rate, including various payment structures and additional costs.

HELOC Payment Phases

A HELOC features two distinct financial periods: the draw period and the repayment period. During the initial draw period, which commonly lasts between 5 to 10 years, borrowers can access funds as needed, up to their approved credit limit. Many HELOCs allow for interest-only payments during this phase, meaning the minimum monthly payment covers only the interest accrued on the outstanding balance. While this can result in lower payments, the principal balance does not decrease unless additional payments are made beyond the minimum required. Borrowers can repay and re-borrow funds multiple times within this period.

Once the draw period concludes, the HELOC transitions into the repayment period, which can extend for 10 to 20 years. During this subsequent phase, borrowers can no longer draw new funds from the line of credit. Instead, payments become fully amortizing, requiring the borrower to pay both principal and interest on the outstanding balance. This shift often results in significantly higher monthly payments compared to the interest-only payments of the draw period, as the principal amount must now be repaid.

Additional HELOC Costs

Beyond interest, a HELOC can involve various other fees and charges:

• Closing costs: These upfront expenses typically range from 2% to 5% of the total credit line. They can include appraisal, origination, and title search fees. Some lenders offer no-closing-cost HELOCs, but these often have higher interest rates.
• Annual fees: Ranging from $5 to $250, these are sometimes charged to maintain the line of credit each year.
• Transaction fees: These may apply each time funds are drawn, potentially ranging from $10 to $50 per transaction, though not all lenders impose them.
• Inactivity fees: Between $5 and $500, these can be assessed if the HELOC is not used for a certain period.
• Early closure fees: A flat fee of $200 to $500 or 2% to 5% of the outstanding balance might be charged if the HELOC is paid off and closed before a specified timeframe, often within the first few years.

How Your HELOC Payments are Determined

The amount of your HELOC payment is influenced by its variable interest rate. Most HELOCs feature variable rates that fluctuate over time. This variable rate is calculated by adding a fixed percentage (a margin) to a financial index, most commonly the U.S. prime rate. As the prime rate changes, your HELOC interest rate and monthly payment will adjust. While the margin is set by the lender and remains constant, the fluctuating index directly impacts the interest charged.

The outstanding principal balance plays a role in determining payment amounts. A larger borrowed amount results in higher interest charges during the draw period and greater principal and interest payments during repayment. As you draw more funds, the minimum payment will increase because the interest is calculated on a larger balance. The current payment phase (interest-only draw or principal-and-interest repayment) alters the composition and minimum amount due. Payments are made monthly, reflecting the current interest rate, outstanding balance, and the HELOC’s phase requirements.