What Is a Draw Period and How Does It Work in Credit Agreements?

Borrowing money often comes with specific terms that dictate when and how funds can be accessed. One such term is the draw period, which applies to certain types of credit agreements and affects how borrowers use their available credit before repayment begins.

Purpose in Credit Agreements

Lenders use draw periods to let borrowers access funds incrementally rather than as a lump sum. This structure is common in financial products like home equity lines of credit (HELOCs) and business credit facilities, where borrowers may not need the full loan amount immediately but require access over time. By allowing withdrawals as needed, borrowers can manage expenses while minimizing unnecessary debt.

For lenders, draw periods help control how funds are disbursed, reducing risk. Borrowers may need to meet conditions such as maintaining a specific loan-to-value ratio or providing updated financial statements to remain creditworthy. If a borrower’s financial situation declines, lenders can adjust credit limits or freeze access to funds.

Eligibility Requirements

Qualifying for a credit agreement with a draw period depends on financial and credit factors. A strong credit score is often required, with most lenders preferring a FICO score of at least 680 for HELOCs. Higher scores can lead to better terms, such as lower interest rates or higher credit limits. Business credit facilities may require a company to show consistent revenue and profitability.

Lenders also evaluate income stability. Individual borrowers typically need to provide W-2s, tax returns, and bank statements. Self-employed applicants may need additional documentation, such as profit and loss statements or 1099 forms. Businesses must often submit financial statements, including balance sheets and cash flow reports.

Collateral is often required for secured credit agreements like HELOCs or asset-based business credit lines. Lenders assess the value of the underlying asset—such as a home or business equipment—to determine the maximum credit limit. A loan-to-value (LTV) ratio of 80% or lower is preferred, meaning a borrower with a home valued at $300,000 might qualify for a HELOC of up to $240,000. If the collateral’s value declines, lenders may reassess the credit limit or impose additional conditions before allowing further withdrawals.

Interest and Payment Structure

Credit agreements with draw periods often have variable interest rates, meaning payments fluctuate based on benchmark rates like the prime rate or the Secured Overnight Financing Rate (SOFR). A HELOC, for example, might be structured as “prime + 1%,” so if the prime rate is 8%, the borrower pays 9% in interest.

During the draw period, many agreements require only interest payments on the borrowed amount, keeping initial costs lower. While this benefits borrowers using HELOCs for renovations or business owners managing short-term expenses, it also means higher payments once the draw period ends.

Some lenders allow voluntary principal payments during the draw period, helping borrowers reduce their overall debt before full repayment begins. Additionally, some agreements impose minimum withdrawal requirements or fees for inactivity, encouraging borrowers to use the credit line rather than leaving it open without drawing funds.

Accessing Funds Within the Draw Period

Once approved, borrowers can access funds through checkbooks, debit cards, or online transfers, depending on the lender’s policies. Some agreements allow scheduled disbursements, where funds are automatically transferred in set amounts over time, which can be useful for ongoing projects or phased business expenses.

Lenders may impose minimum withdrawal amounts or frequency limits. A business credit facility might require each draw to be at least $5,000, while a HELOC could limit the number of transfers per month. Some agreements also include transaction fees for each withdrawal. Borrowers should review these terms to avoid unnecessary costs.

Transition to Repayment Phase

Once the draw period ends, borrowers enter the repayment phase, which typically requires full principal and interest payments. This transition can significantly increase monthly obligations, especially for those who borrowed large amounts without making principal reductions. For example, a borrower with a $50,000 HELOC balance at 8% interest who previously paid only $333 per month in interest could see their payment rise to over $600 if the repayment term is 10 years.

Repayment terms vary by agreement. Some require immediate full repayment, while others offer amortized schedules that spread payments over several years. In cases where a balloon payment is due, borrowers must either pay the remaining balance in one lump sum or refinance into a new loan. Those unable to meet these obligations may face penalties or foreclosure if the credit line was secured by collateral. Some lenders offer loan modifications or extensions, but these often come with additional fees or stricter terms. Reviewing repayment conditions well before the draw period ends can help borrowers avoid financial strain.