How Does HELOC Repayment Work

If you own a home, you may come across the term “home equity line of credit,” or HELOC. A HELOC makes it convenient for homeowners to leverage the equity of their existing home to borrow more money without selling their house or refinancing their old loan.

A home equity line of credit has its benefits and is one of the most popular borrowing options for American homeowners. But what’s the process, and how does HELOC repayment work? Here’s what you need to know:

What Is a HELOC?

A HELOC is a secured loan where you borrow against your home equity and your house acts as the collateral. Usually, you can borrow 60 to 85 percent of the equity, determined through assessment. HELOCs have a lower interest rate compared to other types of secured loans in the market. Since collateral makes any borrower more attractive to lenders, a HELOC makes it easier for homeowners to borrow.

What is also interesting about HELOCs is how they function for borrowers. They work similarly to how a credit card works. HELOCs provide a credit limit to the borrowers, but the borrowers don’t have to use the entire amount and they only have to repay the amount they use.

HELOCs have two phases:

1. Draw period
2. Repayment period

The draw period is the time when you can borrow credit as needed. It can last anywhere from 5 to 10 years. The exact duration depends on the terms and conditions set out by your lender. During this time, you only need to pay interest on the amount you have borrowed. If your lender allows, you can also repay the principal.

When the draw period ends, the repayment period begins. During the repayment period, you cannot borrow any more. Your obligation to repay kicks in—you must repay the total amount borrowed, including the interest. Typically, the HELOC repayment period is usually 10 to 20 years.

Lenders can offer HELOCs at either a fixed or variable interest rate. When HELOCs have a variable APR, the repayment amount fluctuates throughout the repayment period. Don’t forget to look closely at your HELOC agreement to determine your repayment responsibilities before repayment begins. You can set up automatic monthly payments or pay the entire amount in one shot.

There are other options for repaying your HELOC as well:

You Can Make Payments During the Period Draw Period

If you feel that repaying the entire principal and interest during the repayment period will put too much of a strain on your finances, you can consider additional payments during the draw period.

Payments during this period go toward repaying the interest first, and the balance covers the principal. However, some lenders levy a prepayment penalty for early repayments. Make sure to check your loan agreement to avoid last-minute surprises.

You Can Renew Your HELOC

Another option is to renew the HELOC, which, in turn, resets the draw period. You can defer the repayment of your principal and interest, though, you will need to pay interest on the renewed HELOC.

Best Tips to Manage a HELOC

Here are some handy tips for managing your HELOC so you can get the most benefit out of it:

Calculate the Total Amount You Owe and Interest Before the Repayment Period Begins

A HELOC calculator can be a useful tool. Knowing the amount due before you enter the repayment phase helps you plan your payments and manage your finances better. Since the repayment lasts for 10 to 20 years, it’s important to look ahead.

If your HELOC is on a variable APR, it is advisable to start paying off the balance before your repayment period begins, provided the lender allows it. You can also consider refinancing the HELOC to a fixed-rate loan to enjoy better stability.

Pay Attention to Your Debt-To-Income Levels and Credit Score

Your credit score and debt-to-income ratio significantly impact whether the lender will extend your HELOC and on what terms. The higher your credit score, the better your chances are. And maintaining a low debt-to-income ratio also shows lenders that you have sufficient liquidity to repay a HELOC after meeting your current debt obligations. Moreover, if you have a higher level of equity in your home, you can expect a higher credit limit for your HELOC.

Consider Rolling Over Your HELOC to Your First Mortgage

If you are concerned about multiple payments while repaying your HELOC, you can consider consolidating the balance as a refinance of your existing mortgage. This results in a single payment, making it easier to manage. However, this can impact your ability to make more withdrawals under the HELOC. Be sure to take into account the current mortgage rates and the closing costs involved.

Check Whether You Need to Make a Balloon Payment

Some lenders specify that your HELOC repayment will involve a balloon payment. A balloon payment means that at the end of your draw period, you have to pay the HELOC balance as a lump sum. This can be a substantial sum of money, and you’ll need to plan your finances to make sure you’re able to make this happen.

The lender can foreclose on your house if you fail to pay the amount. Check the loan agreement to know whether your HELOC has balloon payment requirements.

Be Sure About the Interest Rate During HELOC Repayment

Usually, lenders inform their customers about the repayment interest rate at least six months before the end of the draw period. However, it doesn’t hurt to double-check before your repayment period begins what the repayment terms will be.

Still Have Questions?

Sometimes, the best resource for information about home loans and HELOCs is to speak with an expert. If you still have questions, reach out to a Home Loan Guide at Solarity Credit Union. They can answer your questions about how does HELOC repayment work and help you determine if it’s the right option for you.