HELOC draw period: What you should know

If you're a homeowner and need to access funds for renovations, large purchases, or other expenses, you may have considered getting a home equity line of credit (HELOC). A HELOC is a type of revolving credit that allows homeowners to borrow against the equity they have built up in their homes. HELOCs often provide lower interest rates, more flexibility and higher limits compared to other types of loans and credit cards.

As with any loan, it’s important to understand all the details of a HELOC before signing on the dotted line. One of the most critical aspects of a HELOC is the draw period. In this guide, we'll explain what the draw period is, how it works, and how you can make the most of it.

What you’ll learn

• What is the HELOC draw period?
• How the draw period works
• Strategies for managing the draw period
• Transition to the repayment period
• Using the draw period to your advantage

What is the HELOC draw period?

A HELOC has two main phases: The draw period and the repayment period. The draw period is the initial phase, typically lasting five to 10 years. During this time, you can withdraw funds up to your approved credit limit as needed.

Unlike traditional loans, for interest-only HELOCs like Alliant offers you’re only required to make minimum payments on the interest during this period, though you can pay down the principal if you choose. This can help keep your monthly payments low but may result in a larger balance that needs to be repaid once the draw period ends.

How the draw period works

During the draw period, you can access funds from your HELOC using checks or online transfers. As mentioned above, you're usually only required to make minimum payments on the interest during this time. However, it’s important to keep in mind that this is typically a variable interest rate and can fluctuate throughout the draw period.

Some lenders offer a fixed interest rate for a set period at the start of the loan. This can be beneficial if you want to lock in a lower interest rate and make consistent payments during the initial phase of your loan.

Most HELOCs don't impose limits on how many times you can withdraw funds during the draw period. As long as you stay within your approved credit limit, you can access the funds whenever you need them. Similarly, there are no restrictions on how you can use the funds, giving you the flexibility to use them for everything from home renovations to medical bills.

Strategies for managing the draw period

While suddenly gaining access to a large amount of credit can be tempting, it’s important to have a plan for managing your HELOC during the draw period. Here are some strategies to consider.

• Create a budget: Before accessing your HELOC, create a budget to determine how much you can comfortably borrow and repay each month. This will help you avoid overborrowing and help ensure you have enough funds to cover your minimum payments.
• Strategic use of funds: Focus on using your HELOC for expenses that will either improve your financial situation, like consolidating high-interest debt, or add value to your home. An added bonus to using your HELOC for home improvements is that the interest may be tax-deductible.
• Stay informed on changes to interest rates: HELOC interest rates are usually variable. Keep an eye on any fluctuations and adjust your budget accordingly to accommodate any potential changes in your monthly payments.
• Early principal payments: Although you’re typically only required to pay interest during the draw period, making principal payments can significantly reduce your debt burden and ease the transition into the repayment phase. Consider making early principal payments on your HELOC whenever possible.

Transition to the repayment period

When the draw period ends, you’ll enter the repayment phase. During this 10- to 20-year period, you will no longer be able to use the funds from your HELOC and will have to begin repaying both interest and principal. Your monthly payments will likely increase significantly with the addition of principal payments, especially if you’ve only been paying the minimum during the draw period.

Proactively planning for this transition can prevent any financial shock and help you stay on track with your payments. Here are a few things to keep in mind during the repayment period.

• Budgeting for higher payments: Your monthly payments will likely increase during the repayment phase. Make sure to budget accordingly and adjust your spending habits if necessary.
• Refinancing options: If you find yourself having trouble making your higher payments during the repayment period, consider refinancing your HELOC. This could involve extending the repayment period or converting it into a fixed-rate loan, providing more stability and predictability in your monthly payments. Remember that refinancing can come with additional fees, so it's important to carefully weigh the pros and cons before making a decision.
• Avoid defaulting on your HELOC: Defaulting on your HELOC can have serious consequences, such as damage to your credit score and potential foreclosure of your home. If you’re struggling to make payments, contact your lender as soon as possible to discuss potential solutions.
• Continue making extra payments: Just because you’re now in the repayment phase doesn’t mean you should stop making extra principal payments. Paying off your HELOC sooner can save you thousands of dollars in interest over the life of the loan.

Using the draw period to your advantage

The draw period is your opportunity to strategically manage your HELOC for maximum benefit. Be sure to approach it with a clear financial plan, borrow responsibly, and consider making early principal payments to reduce your debt load before the repayment phase begins. Keep a close eye on interest rates and regularly monitor your outstanding balance to stay financially prepared for any potential changes in monthly payments.

When used wisely, a HELOC can be an exceptional financial tool for accessing the equity in your home to improve your financial situation. Whether you're using the funds for major home improvements, paying off high-interest debt, or taking advantage of investment opportunities, smart management of your HELOCs draw period can provide increased financial flexibility while minimizing overall borrowing costs.