A HELOC (home equity line of credit) is one of the most popular loans tied to a home’s equity, and they’re one of smartest ways to pay for home improvements. And that’s because HELOC terms are more flexible than many of its alternatives.
So how does a home equity line of credit work?
A HELOC offers financing as a revolving line of credit, similar to a credit card. A HELOC loan has two phases: a draw period and a repayment period. While other renovation loans, such as a home equity loan, offers financing via a lump sum initially, a HELOC allows you to access funds on an as-needed basis during a draw period, paying interest only until the repayment period begins.
Sounding like the type of financing you may be interested in?
This guide will dive deeper into HELOC draw period terms and answer questions like how does paying back a HELOC work?
What is a Draw Period for a HELOC?
When you’re approved for a HELOC, you’re given a line of credit in which you can draw funds from at any time during a set time period — this is your draw period. During this draw period, your HELOC works similar to a credit card in which you can take out any amount of money up to a credit limit as often as you’d like. This period typically lasts around 5-10 years, and during this time, the homeowner will only be expected to pay interest — at a fluctuating rate — on the amount withdrawn.
As of August 16, 2023, the average HELOC interest rates were 8.80% based on a $30,000 credit line or loan — up from 8.74% just the previous week. Since HELOCs have a variable interest rate, these values will change based on the prime rate set by the Federal Reserve, as well as the possibility of generous rates being provided by a few home equity lenders, which is why it pays to shop around for the best offer.
While the Federal Reserve has been working to tame the current inflation, rates still remain high. But HELOCs in general are still more competitively priced than unsecured loans, which are currently ranging around 11% due to the added risk lenders have to endure.
Can You Pay Off a HELOC Early?
During a HELOC draw period, you’ll only be required to pay interest on the amount you’ve withdrawn. But you do have the option to start paying the principal amount as well, giving you the flexibility to choose the repayment structure that works best for you. In this case, your lender can set minimum monthly payments that you make along with the interest.
Pro Tip: Try inputting your info into a HELOC monthly payment calendar to help you determine what type of minimum payments you can handle throughout the draw period.
Even if you don’t start principal payments until the repayment period, can you pay off a HELOC early? Sure. You can pay off the remaining balance owed against your HELOC at any time. If you choose to do so, your lender may offer you the option to close the line of credit or keep it open for future borrowing.
How Many Times Can You Draw From Your HELOC?
There is no limit to the number of times you can access your funds throughout the draw period. You can withdraw money from your HELOC as many times as you’d like on a revolving basis, as long as the funds are still available — aka, you’re still within your total approved credit limit.
This credit limit is typically up to 80% of your home’s current equity (what it’s currently worth minus your existing mortgage).
For example, if your home is worth $400,000, and you owe $250,000, you can qualify for a HELOC up to $70,000. (80% multiplied by 400,000, minus 250,000.)
How Long are HELOC Loans in a Draw Period?
A HELOC draw period typically lasts from 5-10 years, with most lenders offering 10 years to draw from your line of credit. This length will vary from lender to lender, but a longer draw period does offer benefits to homeowners who are currently paying their first mortgage as well. By choosing to hold off on paying your principal amount until the repayment period starts, or paying minimum monthly payments throughout the draw period, you can better manage your expenses during construction and ease into larger repayments.
What is a 30-Year HELOC with a 10-Year Draw Period?
A 30-year HELOC with a 10-Year draw period is one HELOC payment example that is available to homeowners. In this scenario, you have 10 years in which you can access your funds at any time, while only paying monthly interest on the loan. Once that ends, you’ll enter the repayment period for the remaining 20 years (of the 30-year term), in which you’ll owe interest and the principal amount in monthly payments.
Again, this repayment structure can help homeowners avoid the whiplash of diving right into larger monthly payments by paying interest only for the first 10 years.
What is a 10-Year Interest Only HELOC?
A 10-year interest-only HELOC refers to the line of credit during its first several years — or the draw period. This is the period where you can access funds as often as you’d like within your credit limit, and only pay interest on that amount until that 10-year period ends.
What Happens When Your HELOC Draw Period Ends?
We’ve mentioned this repayment period a couple of times now, but how does paying back a HELOC work? When the HELOC draw period ends, your repayment period will begin. During this time, your HELOC functions more like a regular loan, including its home equity loan alternatives. Your monthly payments will now include both interest and principal until the total loan amount is paid off.
It’s important to note that while your principal monthly payments will remain consistent, your interest rate will fluctuate over the life of your loan. Depending on the current market conditions, you could end up paying back more than you expected when all is said and done.
Pro Tip: Some HELOCs may also require a balloon payment of the entire balance plus accrued interest when the draw period ends. Make sure to discuss this with your lender before you apply.
Preparing for the End of the Draw Period and Beginning Repayment
How does a HELOC work in terms of repayments once the draw period ends? While the repayment structure of a HELOC is much less aggressive than other home improvement loans, moving into the Repayment period can still be a bit of a shock. Your monthly payments will increase substantially compared to the interest-only payments you made during the draw period.
It’s vital to plan ahead for the budget adjustment that you’ll have to make during the repayment period. In many cases, these payments can be more than double what you were paying during the draw period. And just like your monthly payments during this time, this amount could change month-to-month based on the variable interest rate as it rises and falls along with the prime rate index. Take advantage of a HELOC monthly payment calculator and talk to your financial advisor on the best way to make a financial shift to manage these payments if necessary.
Pro Tip: Explore repayment options before the draw period ends. If you’re looking to lower your monthly payments during the repayment period, consider starting to make payments toward your interest during the draw period if your loan allows. This will help lower your monthly payments moving forward but reducing the overall balance you need to pay off.
What is the Monthly Payment on a $50,000 HELOC?
So how does a HELOC work based on what you borrowed? The principal, interest, and length of your loan will all impact your monthly payments. So to calculate what you’ll owe each month, here’s the two-step formula to follow:
- A = P(1+rt)
- A = Principal + Interest
- P = Principal
- R = Rate
- T = Time (in years)
- Then, take the total amount (A) and divide it by the number of months.
- A / # of months = monthly payment
Here’s a HELOC payment example based on a $50,000 HELOC based on a 8% interest rate and a 10-year term:
- A = P(1+rt)
- A = $50,000 (1+(0.08)(10))
- A = $50,000 (1+0.80)
- A = $50,000 * 1.80
- A = $90,000
The total payment will be $90,000 for a $50,000 HELOC with a 10-year term and 8% interest rate. You can then take that amount and divide it by the total number of months you have to repay the loan. (90,000 / 120 = $750 per month.)
Remember this number will change as interest rates do!
Take advantage of any HELOC payment calculator online to help you get a better idea of what your specific monthly payments may look like based on your desired loan amount and repayment length.
Most Common Uses of a HELOC
HELOCs are a great way to take advantage of the equity you’ve built in your home to cover a major expense or repay a debt. Here are some of the most common ways people utilize HELOC loans.
Home Renovation and Improvement
When compared to cash-out refis and personal loans, HELOCs are the far superior choice for larger home renovation projects. Not only does it allow you to borrow more at a lower rate due to being secured by your home, but it also doesn’t require you to finance, which could mean sacrificing the great low rate you currently have. Many homeowners use HELOCs for kitchen renovations, bathroom upgrades, outdoor living spaces, and basement remodels.
Pro Tip: A RenoFi HELOC allows you to borrow even more for your renovation wishlist since it’s based on the after renovation value of your home versus the current. Contact one of our Renovation Advisors today to learn more.
Since HELOCs typically have a lower interest rate than unsecured loans and offer simplified payment terms, they are a great way to pay off credit cards or consolidate other types of high-interest debts.
If home equity loan rates are lower than student loan rates, many people will take advantage of HELOCs to pay for tuition. Their repayment terms are often more appealing and flexible as well.
Emergency Expenses Having an emergency fund of 3-6 months of living expenses is always a good idea, and a HELOC can provide a solution for accessing cash quickly — and on an as-need basis. This can include medical emergencies, repairs, or costs associated with unforeseen events or tragedies.
When Not to Use a HELOC
Despite its flexibility and low rates, a HELOC won’t always be the best loan for every home renovation. Here are two examples of when financing with a HELOC may not be the best move.
One of the biggest benefits of a HELOC is the length of time that they allow borrowers to access funds on an as-need basis. So they make the most sense if you know you won’t be able to begin paying back the funds immediately. These loans are better suited for longer-term financing required for larger expenses, not temporary expenses.
Having continuous access to funds while only paying interest can make it very easy to overspend. If you’re pursuing a risk investment or speculative venture that increases the likelihood that you’ll only increase your debt or spend more than your budget allows, a HELOC probably isn’t the best choice. The flexibility it affords only requires more discipline, and if your investment’s circumstances make that hard to control, it could be detrimental to your financial stability.
When to Use a HELOC vs. Home Equity Loan
Both HELOCs and Home Equity Loans are great options to finance mid to large scale renovation projects. And that’s because they offer some of the same benefits — such as being a secured loan, using your home equity, and providing tax benefits. But how does a home equity line of credit work compared to a home equity loan? There are some key differences that will help determine when you should use one of these loans over the other. So How does a HELOC work differently than a home equity loan?
Due to the revolving credit structure of a HELOC, these loans offer a lot more flexibility for varying expenses. If homeowners aren’t exactly sure how much of their loan they’ll need for their home improvements or are pursuing on-going projects over a longer period of time, they can access only what they need, when they need it, making them a more suitable option for homeowners with changing financial needs.
Home equity loans provide the loan amount in one, upfront lump sum. Their repayment period also starts right away, so you’re jumping right into monthly interest and principal payments from the get-go. For this reason, these loans are better for one-time expenses with known costs. But unlike a HELOC’s variable interest rates, they do have fixed interest, which also allows homeowners to better budget their monthly payments.
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Benefits of Using RenoFi HELOC for Renovation
Now that we’ve answered the questions like how do HELOC payments work? and how long are HELOC loans’ repayment periods? You probably have a good idea as to why these loans are so appealing to many homeowners when it comes to renovating their home. But let’s recap some of the biggest benefits of a HELOC anyway.
- Flexibility: HELOC loans allow homeowners to access funds only as needed during the draw period instead of all in one lump sum like a home equity loan, while only paying interest on the amount you draw versus the whole credit line amount. This offers flexibility for ongoing or multiple home improvement projects, as well as any unforeseen changes along the way.
- Competitive Interest Rates: HELOCs often offer competitive interest rates compared to other renovation financing options. But don’t forget, they can increase due to the nature of a variable interest rate.
- Potential Tax Advantages: Using a HELOC loan for qualified home improvements may be tax deductible come tax time, saving you even more money on your loan. To know for sure, consult a tax advisor.
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Steps to Use HELOC for Renovation
If you’re thinking that a HELOC is going to be the best option for your home improvements, then congrats! That’s a big step! But you still have some big ones ahead of you too. Here are some important steps to plan for during the process.
- Assessment and Planning:
Determine your home’s value by obtaining an appraisal or using an online tool to estimate your home’s worth so you have a good idea of what you’ll be able to borrow. Evaluate your renovation needs and prioritize which items are must-haves and establish a budget for each improvement.
- Contact the Lender:
Research lenders in your area that offer HELOCs and compare their interest rates, fees, and eligibility requirements. Reach out to them for more information and any specific criteria or discounts they may be able to offer.
- Provide Documentation:
Gather all the necessary documents for your loan application, such as W-2 forms, tax returns, and proof of income. Lenders may also require documentation related to your home, such as property insurance and a title search. You should also have a detailed project budget/proposal, blueprints, and contract from your contractor.
- Approval and Accessing Funds:
Once you complete the loan application and provide all the documentation above, you should get notification of whether or not you’ve been approved. If you are approved, you can start accessing your funds as soon as you’d like.
- Using Funds Wisely:
Remember to budget and be smart throughout your draw period. Use the funds exclusively for the planned renovation, and keep track of spending along the way. The last thing you want is to end up overspending along the way and not having the funding you need when you really need it.
Why You Should Get A RenoFi Loan: RenoFi’s HELOCs are Unmatched
If you’re looking to take advantage of the flexibility, flexible access, and longer repayment that HELOCs provide, then you need a RenoFi HELOC loan. All RenoFi loans give you the benefits of the loan itself with one major difference: you can boost your borrowing power based on the after-renovation value of your home versus its current value. For major home renovations and larger scale projects, this is crucial to helping you get everything crossed off your home wishlist in one shot.
Even further, RenoFi HELOCs (and all of our renovation loans) offer lower interest rates and monthly payments than most alternatives. We partner with awesome credit unions who help us offer these lower rates and give you even more flexibility based on your financial situation, while helping you every step of the process, from applying for your loan to getting all the necessary documentation from your contractor.
To learn more about how RenoFi HELOCs work or how we can help finance your renovation in the smartest way possible, try the RenoFi Loan Calculator to see how much you can borrow, or contact a RenoFi Advisor to explore all of your options.
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