In this article, learn how to calculate payments for Home Equity Lines of Credit (HELOCs) and the factors that influence them.
How HELOCs Work
Each HELOC consists of two phases: the draw period and the repayment period. During the draw period of your HELOC, you can borrow up to your credit limit for any purpose. Like a credit card, you can spend the available balance on your line of credit after repaying the balance. The draw period for your HELOC may vary depending on the lending bank, but it typically lasts up to 10 years.
Once your HELOC draw period ends, you will enter the repayment period. During this time, you will not be able to borrow more from your HELOC. You will make minimum monthly payments until the borrowed amount is paid off, just like any other loan. The repayment period of a HELOC varies by lending bank and is usually around 10 to 20 years.
Note: HELOCs are secured by your home. The amount you can borrow generally depends on the value of your home and how much equity you have in it, along with other factors. Your monthly payments will be based on the amount you actually used and your interest rate, not on the total credit limit.
What Does a HELOC Payment Include?
Like other loans, a HELOC payment consists of two components: principal and interest. Principal is the amount you have borrowed from your HELOC. Interest is the additional amount you pay for borrowing the funds.
HELOCs typically have variable interest rates, meaning the rate can change over time and is based on a certain index rate. As market rates increase, your HELOC rate and therefore your monthly payments will also rise. Conversely, as market rates decrease, your interest rate and payments may also decrease.
Whether you are in the draw period or the repayment period, this period will affect what is included in your HELOC payment.
Note: Some HELOCs allow for interest-only payments during the draw period before you’re required to start repaying both principal and interest in the repayment period.
How to Calculate HELOC Payments
Your HELOC payment amounts depend on whether you are in the draw period or the repayment period. Let’s take a closer look at how to calculate payments during the different stages of your credit line.
Draw Period
During the draw period of your HELOC, you will have a variable interest rate and a payment based on the amount you have used from your credit line. Repayment terms will depend on the lending bank. Some banks may require you to pay the accrued interest and a portion of your principal balance, similar to a credit card.
In many cases, the minimum payments during the draw period may not be enough to pay down the loan. In fact, some banks may only require interest payments during the draw period. However, the principal balance will accrue interest during this time, and if your principal increases, your interest payments will also rise.
You can pay down the principal during the draw period, although it is not required. Some borrowers may prefer to pay off the HELOC entirely as soon as possible so they can use it again during the draw period.
Repayment Period
In the repayment period, you will no longer be able to borrow from the credit line. Instead, the focus shifts to repaying the borrowed amount, along with the interest.
Some banks may require a large payment at the end of the draw period, where you will need to pay off the full balance owed. However, most banks provide an extended repayment period, during which you will pay off your HELOC just like any other loan.
Your payments during the repayment period are amortized and depend on the principal and interest. The amount you will pay will include the outstanding interest as well as enough principal balance to pay off your entire line of credit before the end of the repayment period.
Note: Remember that since HELOCs typically have variable interest rates, your payment amount can change over time. If interest rates for the index your HELOC is tied to increase, your interest rate and monthly payment will also go up. HELOC rates can change once a month.
It is also important to note that if you sell your home during the draw period or repayment period, you may be required to pay off the full balance immediately. Remember that your HELOC is secured by your home. If you no longer own the asset that secures the debt, the bank may want to recover its money.
How to Pay Off a HELOC
When you reach the repayment period of your HELOC, you usually have two options: you can choose to pay off the balance, or you can refinance to change the payment terms.
Make Your Monthly Payments
The most straightforward way to handle the repayment period of your HELOC is simply to repay the loan. You can pay it off immediately or according to the schedule set by the bank. Due to the variable rate, your payments may increase or become unsustainable, which may require you to consider refinancing.
Refinancing
When the draw period on your HELOC ends, you can refinance in several different ways. These methods include:
- Refinancing into a new HELOC with a new draw period, possibly making only interest payments
- Refinancing into a fixed-rate HELOC
- Refinancing into a mortgage loan, which is typically a fixed-term loan that carries a fixed interest rate and fixed monthly payments
- Refinancing into a mortgage, which requires obtaining a new mortgage to pay off your existing mortgage and HELOC
Conclusion
HELOCs can be an excellent tool to help you cover home repairs or renovations, consolidate high-interest debt, send a child to college, and more. But they also carry some risks, including the variable interest rate and the fact that your line of credit is secured by your home.
Like any other type of debt, it’s important to understand the terms of your HELOC before finalizing the agreement. Make sure you are aware of your HELOC credit limit, repayment terms, interest rate, and more.
Frequently Asked Questions (FAQs)
When do payments start on a HELOC?
Typically, the repayment period begins about 10 years after taking out a HELOC. However, you may be required to make payments on the HELOC as soon as you borrow money. However, these payments will be smaller than during the repayment period. Depending on the lending bank, you may only need to make interest payments or interest with a portion of the principal during the draw period.
Are there monthly payments on a HELOC?
HELOCs typically require monthly payments once you start drawing from the line of credit. Your monthly payment will depend on whether you are in the draw period or repayment period, and may include only interest or both interest and principal.
How much can I borrow on a HELOC?
The amount you can borrow on a HELOC generally depends on two key factors: the value of your home and your equity in the home. It will also depend on other factors such as your credit score and income. Lenders generally allow borrowers to take out a certain amount based on their equity. The more equity you have in your home, the more you can borrow.
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Sources:
Consumer Financial Protection Bureau. “What You Should Know About Home Equity Lines of Credit.”
Consumer Financial Protection Bureau. “Home Equity Loans and Home Equity Lines of Credit.”
Source: https://www.thebalancemoney.com/how-payments-are-calculated-for-helocs-5324197
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