When Are HELOC Payments Interest Only?

A Home Equity Line of Credit, or HELOC, provides a revolving line of credit that homeowners can borrow against, using their home’s equity as collateral. This financial tool functions similarly to a credit card. While HELOC payments can be interest-only for a certain period, this is not always the case throughout the entire life of the loan. Understanding the specific phases of a HELOC is important for managing its financial implications.

Understanding HELOC Payment Phases

A HELOC typically consists of two distinct phases: the draw period and the repayment period. During the draw period, which commonly lasts between five and ten years, you can access funds, make payments, and borrow again up to your credit limit. The minimum monthly payment required during this phase is often interest-only, covering only the interest accrued. While making only interest payments is an option, it is also possible to pay down the principal balance during this period, which can help reduce the amount owed later.

When the draw period concludes, the HELOC transitions into the repayment period, typically spanning 10 to 20 years. During this subsequent phase, you can no longer withdraw funds from the line of credit. Instead, your monthly payments will include both principal and interest, aiming to fully amortize the loan balance by the end of the term. This shift marks a change in payment structure, requiring careful financial planning.

How HELOC Interest is Calculated

HELOCs are characterized by variable interest rates. The calculation of this variable rate relies on two primary components: an index and a margin. The index is a benchmark interest rate that reflects broader market conditions, with the Prime Rate being the most commonly used index for HELOCs. The margin is a fixed percentage added to the index by the lender, which remains constant throughout the loan’s life but varies between lenders based on factors like creditworthiness.

The actual interest charged is calculated on the outstanding balance of your HELOC. For instance, if the Prime Rate is 7.5% and the lender’s margin is 1%, your HELOC interest rate would be 8.5%. As the underlying index rate changes, your interest rate and, consequently, your monthly payment amount will adjust accordingly. Lenders typically recalculate interest rates monthly.

Navigating the Repayment Period

The transition from the draw period to the repayment period can lead to a substantial increase in monthly payments. This is because payments shift from being interest-only to including both principal and interest. If only interest payments were made during the draw period, the entire principal balance remains, leading to a potentially much higher payment when amortization begins. This change is often referred to as “payment shock.”

Borrowers should proactively prepare for this transition by understanding their loan terms and budgeting for increased payments. Some lenders provide notifications several months before the draw period ends, detailing the upcoming changes to payment amounts. During the repayment phase, no further funds can be drawn.