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With home equity levels remaining high and property values holding strong or increasing in many markets, many homeowners are looking to tap into their home equity this spring. There are a few ways to do that, but a home equity line of credit (HELOC) is one of the most flexible ways to access your home’s equity, whether your goal is to make renovations, consolidate your debt or cover other major expenses. That’s because, unlike a traditional home equity loan that provides a lump sum loan, a HELOC functions more like a credit card — one that’s secured by your home’s equity.
If you’re considering a HELOC this March, understanding how the draw period works is crucial to maximizing this financial tool. The draw period is the timeframe during which you can access funds from your HELOC, and it typically lasts between five and 10 years. During this phase, borrowers usually have the option to make interest-only payments, which keeps the monthly payments lower but doesn’t reduce the principal balance. Before signing, though, it’s essential to understand the nuances of the draw period and how it affects your financial obligations, both now and in the future.
See how much home equity you could borrow with a HELOC here.
What to know about the HELOC draw period this March
While a HELOC can be a smart home equity borrowing option to consider this March, make sure you understand these three important things about the draw period before borrowing:
The interest-only payments can be deceptive
During the draw period, most HELOCs only require you to make interest payments on the amount you’ve borrowed. This setup keeps your payments low and manageable, making a HELOC appealing for those looking to finance renovations or cover short-term expenses. However, if you’re not paying down the principal, you’re not reducing the total loan balance. You’re simply just keeping up with the interest charges. In other words, the total debt remains unchanged unless you make additional payments beyond the minimum required amount.
As a result, it’s easy for borrowers to fall into the trap of treating their HELOC like an endless source of funds without considering the long-term implications. Once the draw period ends, though, the repayment period begins, often with much higher monthly payments as the principal repayment kicks in. So, if you’ve borrowed a significant amount, the jump in required payments could strain your budget, especially if you haven’t planned for it. To mitigate this risk, consider making principal payments during the draw period, too, even if they’re not required.
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The draw period repayment options vary by lender
While many HELOCs allow interest-only payments during the draw period, the payment structures can vary significantly between financial institutions. In addition to interest-only draw periods, some lenders offer other repayment options during the draw period, including:
- Minimum payments that include some principal reduction
- Fixed-payment options that convert portions of your balance to installment loans
- “Hybrid” HELOCs that combine features of both lines of credit and fixed-rate loans
So, as you’re comparing HELOC offers, you may want to look beyond the interest rate to understand exactly how payments are calculated during the draw period. Ask specific questions about the minimum payment requirements, whether any principal reduction is required and what happens if you only make minimum payments throughout the entire draw period. These details can significantly impact your monthly budget and long-term financial health, so it’s important to fully understand what you’re signing up for.
Your credit line could be adjusted or frozen during the draw period
A HELOC is a revolving credit line, meaning your lender can adjust or even freeze your credit limit based on changes to your financial standing. For example, if your credit score drops significantly, your home value declines or you face financial hardships, your lender may choose to reduce the amount of credit available to you or even suspend your access to funds altogether.
This potential limitation underscores the importance of maintaining strong financial health throughout the draw period. Keeping up with mortgage payments, avoiding excessive debt and monitoring your credit score can help prevent unexpected disruptions to your HELOC access. If you anticipate needing funds later in the draw period, securing them sooner rather than later could be a wise strategy.
The bottom line
A HELOC can be a valuable financial tool when used responsibly, but certain factors unique to the draw period could result in unintended financial consequences if you aren’t careful. By understanding the implications of interest-only payments, having a clear idea of the draw period repayment requirements and knowing the impact of your financial standing on credit availability, you can maximize your HELOC’s benefits while avoiding some of the common financial pitfalls.
