HELOC: Explaining the 10-Year Interest-Only and 20-Year Repayment Periods
When you get a home equity line of credit, or HELOC, they come with two phases:
10 year interest-only draw period
20-year repayment period
During the interest-only period, you pay interest on the amount borrowed. You do not have to pay the principal, though you can if you’d like. You can draw money out and pay it off as you wish, hence the name “draw period.”
At the end of 10 years, you must start paying off the balance. You will enter a repayment period – typically 20 years but sometimes 10 or 15 – in which you pay a principal and interest payment similar to a regular mortgage. You may not draw additional funds during this phase.
Interest-Only HELOC Example
Here’s an example to make things clearer.
Draw Period
You open a HELOC with an available limit of $200,000. You take $100,000 in cash at closing. The interest rate is 7%.
Your monthly payment is $583 ($100,000 X 0.07 / 12). If you pay this each month, your HELOC balance stays at $100,000 because you are not paying any principal.
Over 10 years, you pay down the balance as low as $50,000 and draw up to $150,000 of your $200,000 limit. You only own interest on the borrowed amount in any given month.
Repayment Period
After 10 years, the HELOC enters the repayment period. Assume you have a balance of $125,000 and have 20 years to pay it off.
Your payment rises from $730 (interest-only) to $970 (the 20-year principal and interest payment) assuming a 7% interest rate.
You would make the principal and interest payment for 20 years, then the HELOC would be paid off.
How Are HELOC Interest Rates Determined During The Draw and Repayment Periods?
Most HELOC rates are variable and based on the prime rate. The prime rate usually equals the federal funds rate plus three.
HELOCs are typically quoted as “prime plus one” or “prime minus one-half.” The “spread” is determined by your credit score, loan-to-value, and other factors.
Your HELOC rate can change based on economic conditions and Federal Reserve actions. This can be good or bad, depending on whether the Fed is currently cutting or hiking rates.
Locking in Your HELOC
HELOC rates are variable during both the draw and repayment periods. To lock in a rate, many homeowners use a cash-out refinance to consolidate their HELOC into their first mortgage.
Another option is to lock in your HELOC rate, turning it into a home equity loan. Some lenders allow you to lock in a portion of your HELOC. This allows you to continue borrowing with the unused portion.
You can no longer draw funds on the locked portion and you may have to make principal and interest payments.
Interest-Only HELOC Advantages
IO HELOCs are popular for a reason. Some of their advantages are not available with any other loan type.
Low Payments
The biggest advantage to an interest-only or “IO” HELOC is its low monthly payment. You can borrow a significant amount of money with a relatively low payment.
HELOC Balance | IO Payment @ 7% |
$50,000 | $291 |
$100,000 | $583 |
$200,000 | $1,166 |
$350,000 | $2,041 |
$500,000 | $2,916 |
In comparison, adding $200,000 to your 30-year fixed mortgage would cost an additional $1,331 per month but $1,166 as an interest-only HELOC. That's $165 less, assuming the same 7% interest rate.
Borrow Again
You can also borrow, pay down, and re-borrow funds for up to 10 years. This allows you to complete home improvements in phases, perform multiple property flips, or finance many large expenses.
Does Not Affect Your Primary Mortgage
You can open a HELOC, borrow multiple times, pay it off, and close it without affecting your first mortgage. Homeowners with a low primary mortgage rate gravitate toward HELOCs to avoid a refinance.
Bridge Loan
If you’re buying a home but have not sold your current one, a HELOC can help bridge the gap. Simultaneously open a HELOC on the home you’re buying along with the first mortgage. When you sell your current home, pay down the HELOC to a zero balance. Then you’re left with an available credit line on the new home for which you are not paying interest.
Refinance your HELOC
As you approach your repayment period, you can refinance your HELOC into another one if you qualify, renewing the 10-year draw period.
Check your HELOC eligibility and rates.
Risks of Paying Interest-Only
No principal reduction: You make no progress is paying off the loan if you make the interest-only payment.
Payments rise after 10 years: Your payment could rise hundreds of dollars per month when the loan enters its repayment period.
Easy to overspend: When you have access to potentially $100,000 or more, it’s hard to stick to a budget on your project. Stay disciplined as if the money were coming out of your bank account – because it will someday soon.
Qualify For Your Interest Only HELOC
IO HELOCs are one of the most useful tools available in the home mortgage market. They are more flexible than a traditional mortgage and can enable capital-intensive goals.
