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Mortgage Basics

What Is a Draw Period on a HELOC?

When you need to cover a big expense, such as home remodeling, a child's wedding or an unexpected hospital bill, a home equity line of credit is one option for getting the cash you need. A home equity line of credit (HELOC) is a type of revolving credit that allows you to borrow against the equity in your home. A HELOC "draw period" is the amount of time you have to tap into that available credit.

As you pay down your mortgage, you build equity—the difference between the amount of money you owe on your mortgage and your home's current value. If you owe $300,000 on your mortgage and your home's value is assessed at $600,000, for instance, you have $300,000 in equity. A HELOC lets you borrow up to a percentage of that equity—typically 60% to 85%, depending on your credit score, debt-to-income ratio and other factors. Because a HELOC is a line of credit and not a loan, you don't have to start using the money immediately; you can draw from it at any time during the draw period.

How Do HELOC Draw Periods Work?

Most HELOCs give you a 10-year draw period in which to use the money. During this time, you can draw as much as you need up to your total available credit line. When the draw period ends, you'll have to repay the amount you drew. For example, if you get a $100,000 HELOC and only draw $20,000, you will only have to pay back the $20,000 plus interest, not the full $100,000 you could have drawn.

Some HELOCs require you to draw a minimum amount of funds upfront; others do not. To draw from your HELOC funds, you can use a debit card, write a check, get cash from a bank branch or ATM, or electronically transfer the money into your bank account.

During the draw period, your monthly HELOC payments are minimal; typically, you'll only have to pay the interest on the amount you've borrowed. Depending on your loan terms, you may be able to make payments on the loan principal as well or even pay the loan off in full (although some lenders charge a fee if you repay the loan early).

When the draw period ends, your HELOC closes. You then repay the balance of the loan, generally over 20 years, or refinance to a new loan (more on that in a moment). Some HELOCs have a balloon repayment plan, meaning the entire balance—loan principal and interest—is due at the end of the draw period.

What if you miss a payment during either the draw period or the repayment period? There's generally a grace period after the HELOC payment due date. If you pay within this grace period, you may be charged a late fee or other penalty, but the lender won't report the late payment to the credit bureaus, so it won't affect your credit score. If you make the payment after the grace period has passed, or don't make it at all, the lender will report the missed payment to the credit bureaus, likely hurting your credit score. Check the terms of your loan agreement to verify what your grace period is.

What to Do Before a HELOC Draw Period Ends

To avoid unpleasant surprises, make sure you understand your HELOC's terms and exactly when the draw period ends. Once the HELOC closes, you can no longer draw from it—and you'll start making larger loan payments.

As you approach the end of your draw period, confirm the balance you will owe after the HELOC closes, how long your repayment period lasts, and what your monthly payments will be. If you have a variable-rate HELOC, your payments could change during the course of repayment as your interest rate fluctuates; however, most HELOCs cap how much the interest rate can rise at one time and over the loan term.

If you need to reduce your monthly payments, the time to explore your options is well before the draw period expires. For example, many lenders will let you convert a variable-rate HELOC to a fixed-rate HELOC, but you must do so before the draw period ends.

Paying back at least some of the principal during the draw period reduces the total amount you will owe when the HELOC closes. If you pay it all back, you'll have a zero balance at the end of the draw period. In this case, your loan will close—generally with no further payments or action required on your part.

If you didn't make principal payments during the draw period, be prepared for a substantial increase in payments after the HELOC closes. Often, borrowers find their payments more than double compared with the interest-only payments they were making during the draw period. Remember, your home serves as collateral for the HELOC—so unless you can cover the loan payments, you could lose your home.

Consider Additional Repayment Options

Paying off the HELOC in full before the draw period ends is the best option, leaving you with zero balance at the end of the loan. Review your budget looking for places you can cut costs and save money to put toward the HELOC balance.

If that's not possible, you have several options for refinancing or closing your HELOC before the draw period ends.

  • Refinance to another HELOC. If you have good to excellent credit, you can apply for a new HELOC and use it to pay off the outstanding loan. During the draw period for the new HELOC, you can pay only the interest. However, unless you want to keep kicking the loan-repayment can down the road (and paying a lot more interest in the process), create a plan to chip away at the principal too.
  • Refinance to a home equity loan. Similar to a HELOC, a home equity loan is secured using your home as collateral, and the amount you can borrow depends on your home equity. Unlike a HELOC, a home equity loan is an installment loan repaid in fixed payments over time; you can use it to pay off the HELOC and then pay off the home equity loan.
  • Do a cash-out mortgage refinance. A cash-out refinance replaces your existing mortgage with a new mortgage for more than your previous balance. You'll receive the difference in cash, which you can use for any purpose—in this case, to pay off your HELOC. Mortgages typically have lower interest rates than HELOCs and home equity loans, and if mortgage interest rates have dipped since you originally got your mortgage, this option might save you even more money. But getting a new mortgage eats into your home equity. It can also be expensive, with fees and closing costs that may wipe out any savings.

Whichever refinancing option you're considering, carefully weigh the costs against the potential savings to see if it makes sense for you.

What if your financial situation has changed for the worse since you got the HELOC, and you're having trouble making payments? If you begin missing payments, your credit score may suffer, making it difficult to qualify for loan refinancing. If you find yourself in this predicament, see if your lender is open to some type of loan modification.

How Can a HELOC Affect Your Credit?

When you apply for a HELOC, the lender will perform a hard inquiry into your credit, which can cause a small, temporary dip in your credit score. After you're approved, a HELOC can negatively or positively affect your credit depending on how you use and repay the loan.

For example, if you have lots of high-interest credit card debt, you probably have a high credit utilization ratio, which can lower your credit score. Drawing from your HELOC to pay off your credit card balances could reduce your credit utilization ratio and improve your credit score, as long as you don't run up the credit card bills again. Because HELOCs are secured by your home, your FICO® Score (the credit score most commonly used by lenders) won't reflect them in your credit utilization.

Making on-time payments both during and after the draw period on your HELOC can also help to boost your credit score. Just be aware your monthly payments will increase when your HELOC closes. If you're not prepared to handle them and miss a payment, it could damage your credit score.

Use the HELOC Draw Period Wisely

A HELOC can give you the financial cushion you need to handle a major expense. However, taking out a HELOC is a major decision that could affect your finances for decades to come. Carefully consider the pros and cons, and investigate other alternatives for managing a financial emergency or funding a major project, such as home equity loans, personal loans or credit cards.

If you decide a HELOC is right for you, check your credit report and credit score before you apply. You'll generally need a FICO® Score of at least 680 to qualify for a HELOC. If you're not quite there yet, taking the time to improve your credit score can help you qualify for a loan with better loan terms and a larger credit line, giving you more financial power to achieve your goals.