How Does Paying Back a HELOC Work?

A Home Equity Line of Credit (HELOC) provides homeowners with a revolving credit line, allowing them to borrow against their home’s equity. This financial tool is secured by the home itself, making it a potentially lower-interest option compared to other credit types. Understanding the distinct phases of a HELOC and how its payments are structured is important for managing this type of loan effectively.

Understanding HELOC Draw and Repayment Periods

A HELOC operates in two primary phases: the draw period and the repayment period. During the draw period, borrowers can access funds up to their approved credit limit. This period typically lasts 5 to 10 years. Payments are often interest-only, covering only the accrued interest on the amount borrowed. Borrowers can also make principal payments to reduce their outstanding balance.

Once the draw period concludes, the HELOC transitions into the repayment period. The ability to draw new funds ceases, and the borrower begins making payments that include both principal and interest. The repayment period is designed to fully amortize the outstanding balance over a set term, commonly 10 to 20 years. The combined duration of both periods can extend up to 30 years.

How HELOC Payments are Calculated

HELOC payments are influenced by variable interest rates. These rates are typically tied to a benchmark index, most commonly the U.S. prime rate, plus a fixed percentage known as the margin. The margin remains constant, while the prime rate can change based on broader economic conditions, such as Federal Reserve adjustments. When the prime rate shifts, the HELOC’s interest rate and monthly payment amount will also adjust.

During the draw period, minimum payments are interest-only. For example, a $20,000 balance at a 9% interest rate results in a $150 monthly interest payment. This payment covers only the interest, so the principal balance does not decrease unless additional payments are made.

When the HELOC enters the repayment period, payments become fully amortized, including both principal and interest. The calculation ensures the entire outstanding balance is paid off by the end of the term. This typically results in a higher monthly payment compared to the interest-only payments of the draw period. The monthly payment amount will still vary with changes in the variable interest rate, based on the outstanding balance and remaining term.

Navigating Your HELOC Repayment

Managing a HELOC involves understanding its variable interest rates. Monthly payments can increase or decrease as HELOC rates are tied to the prime rate, which changes with Federal Reserve actions. Borrowers typically see these rate adjustments reflected in their payments within one or two billing cycles.

Making extra principal payments above the minimum required amount can benefit a HELOC borrower. This reduces the outstanding principal balance, lowering the interest accrued over time and potentially decreasing future minimum payments. Paying down the principal can also help borrowers save on interest charges and pay off the loan faster.

The transition from the draw period to the repayment period often brings an increase in monthly payments, as payments shift from interest-only to principal and interest. Lenders generally communicate this upcoming change, providing borrowers time to prepare for higher payment obligations. Borrowers should review their loan agreements to understand the specific terms of this transition.

Refinancing a HELOC offers options for managing repayment, especially as the draw period nears its end or if interest rates become unfavorable. Borrowers might consider converting their HELOC balance to a fixed-rate home equity loan for more predictable payments. Another option is to refinance into a new HELOC, which can restart the draw period and potentially offer new interest rates or terms. Some lenders also allow converting a portion or all of a variable-rate HELOC balance to a fixed rate within the existing HELOC.

Missing a HELOC payment carries immediate consequences. Lenders typically charge late fees, ranging from $25 to $50, and report delinquency to credit bureaus. This negative reporting can damage a borrower’s credit score, potentially by 50 to 100 points or more for a single missed payment. Continued missed payments can lead to the loan going into default, typically after 2 to 4 months of non-payment. Since a HELOC is secured by the home, defaulting can result in legal action, including foreclosure, where the lender may force the property’s sale to recover the debt.