What Is a HELOC Draw Period?

A home equity line of credit (HELOC) allows you to borrow capital against the equity that you have built in your home. These financial products typically have variable interest rates, and you only pay interest when you borrow against the credit limit. Every HELOC has a draw period, that determines how long you can borrow money from the credit line. This guide will explore how HELOC draw periods work and what to know before using this financial product.

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What Is a HELOC Draw Period?

A HELOC draw period is the amount of time that you can borrow against your HELOC’s credit limit before having to pay it back. While you will have to make small minimum monthly payments, any unpaid balance after the draw period converts into a traditional loan.

How Does a HELOC Draw Period Work?

A HELOC draw period allows you to borrow capital against your property. When you get accepted for a HELOC, you will receive a credit limit from your lender. If your HELOC has a $50,000 credit limit, then you can borrow up to $50,000. 

You don’t have to borrow this money at once, and it’s possible to pay very little interest if you don’t rush to use the entire limit. Once the draw period concludes, you can no longer borrow money against the line of credit. Any remaining balance must be repaid in monthly installments. 

The minimum monthly payment is usually 1% of the unpaid balance. If you have borrowed $50,000 against your credit line, you will probably have to make a $500 payment at the end of the month. Each lender has different terms and conditions.

How Does the Repayment During the Draw Period Work?

You will have to make a minimum monthly payment equal to a predetermined percentage of your HELOC’s unpaid balance. While it can be a monthly 1% payment, a higher monthly payment is possible if interest rates increase. Your credit score may also play a role in the monthly repayment.

You can still borrow money against your HELOC while you make monthly payments during the draw period. It’s possible to borrow money from a HELOC, pay it off, and borrow money from it again before the draw period concludes. 

What Common Mistakes Should You Avoid During the Draw Period?

A HELOC gives you financial flexibility, but you should avoid these mistakes during the draw period.

• Immediately spending the funds: You don’t have to burn through your HELOC’s limit right away just because you have extra money to spend. HELOCs accrue interest the moment you borrow against the credit limit. 
• Using a HELOC to shield bad financial habits: A HELOC can enable a toxic lifestyle filled with poor financial decisions. Some homeowners take out HELOCs and end up losing their properties because they can’t keep up with monthly payments after the draw period concludes.
• Not exceeding the minimum monthly payment: The minimum monthly payment is relatively low, especially when comparing it to a home-equity loan. However, you should treat it like a credit card and pay off as much as you can. Interest will continue to compound on the unpaid balance, and since rates are variable, you can end up with a higher interest rate over time.

How Should You Prepare Before the HELOC Draw Period Ends?

The best way to prepare before a HELOC draw period ends is to make as many payments as possible. Trimming the balance now will reduce your monthly loan payments when the HELOC balance converts into an installment loan.

You should also review the HELOC’s terms to determine what happens when the draw period concludes. Some HELOCs have balloon payments instead of converting into installment loans. You should also check if you will have a variable interest rate or a fixed interest rate on the remaining debt.

Other Additional Repayment Options

It’s optimal to pay off your HELOC in full before the draw period ends. You can then walk away from the debt and have equity in your home. However, you have a few choices if you cannot repay your HELOC before the draw period concludes.

Refinance to Another HELOC

You can take out another HELOC and use those proceeds to pay off your current HELOC. You will have a new draw period to catch up on the unpaid balance for your new HELOC. This approach can prevent you from ending up with a balloon payment and give you more time to get back up to date.

Refinance to a Home-equity Loan

Taking out a home-equity loan and using it to pay off the HELOC’s balance is similar, but you won’t have a draw period. Monthly home equity loan payments start right away and are higher than what you’d have to pay for a HELOC. However, home equity loans usually have fixed interest rates, which creates more predictability.

Get a Cash-Out Mortgage Refinance 

You can also use a cash-out refinance to pay off your HELOC. This approach involves changing the rate and terms of your current mortgage. A cash-out mortgage refinance is not a good idea if you have secured a low-interest rate for your current mortgage. However, it can give you more flexibility. For instance, you can extend your mortgage’s duration to keep the monthly payments at a similar level.

How Does a HELOC Affect Your Credit?

Applying for a HELOC will trigger a hard credit check which will temporarily hurt your credit score. It’s easy to recover from a hard credit inquiry, and the entire process takes a few months. 

Your payment history determines how a HELOC affects your credit in the long run. Making on-time payments will improve your credit score. However, any late payments will affect your score. It’s harder to recover from late payments than hard credit checks, but it is possible. Racking up too many late payments and having a high balance can hurt your credit. 

If you use a HELOC responsibly, stay on top of your payments, and make more than the minimum monthly payment, this financial product may improve your credit score.

Find the Best HELOC Lenders from Benzinga’s Top Mortgage Providers

A HELOC is a useful financial product, but not every lender has your best interests in mind. Luckily, these are some of the top HELOC lenders that can guide you through the process and offer competitive rates.

Tapping into a HELOC for Equity

A home equity line of credit allows you to access equity from your home. You’ve earned this equity with every monthly mortgage payment and through property appreciation. While HELOCs can offer many advantages, knowing the downsides is also important. If you make more than the minimum monthly payment and pay off your HELOC before the draw period concludes, you can avoid many of the headaches along the way.

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