HELOC Draw Period vs Repayment Period: Why the Payment Jumps

A line has two lives

A home equity line of credit has two lives. In the first, the draw period, you can borrow, repay and borrow again up to your limit, and the required monthly payment on many lines covers only the interest on what you have drawn. In the second, the repayment period, the line closes to new draws and whatever balance remains is paid down on a schedule, principal and interest together, over a fixed number of years.

The payment in the second life is higher than the payment in the first, sometimes much higher, even if the rate has not moved. Owners who sized the line by the interest-only payment discover this at the transition, which is the worst time to discover it. The fix is simple and rarely done: model the repayment-period payment before you draw, and decide how you will handle it while you still have options.

The mechanism

Interest-only during the draw period

Interest-only means the required payment equals the interest that accrued that month on the outstanding balance, and nothing more. The balance does not fall unless you choose to pay principal. Because most HELOC rates are variable, tied to an index plus a margin, the interest-only payment rises and falls with the index even though the balance is unchanged. Two things can therefore move the payment during the draw period: how much you have drawn, and where the index is.

Amortization during the repayment period

When the draw period ends, the lender converts the balance into an amortizing loan. The payment is calculated so that the balance reaches zero by the end of the repayment period. That calculation adds a principal component that did not exist before, and the shorter the repayment period, the larger that component. A balance that took years to build is now scheduled to be repaid in a fixed window, and the monthly figure reflects that.

An illustrative example

For illustration only, suppose a homeowner has drawn $100,000 and the interest-only payment at the line's current variable rate happens to be $600 a month. These are hypothetical figures chosen for round arithmetic, not a quote, an offer or a guideline.

• In this hypothetical example, if the rate stayed where it was and the balance began amortizing over a 20-year repayment period, the payment would rise to roughly $790 a month, about a third higher than the illustrative interest-only figure.
• If the repayment period in the example were 10 years instead, the payment would rise to roughly $1,170 a month, nearly double the illustrative interest-only figure.
• If the index had also risen by the time the draw period ended, both figures in the example would be higher still, because the amortizing payment is computed at the then-current rate.

The example makes the structural point: the jump comes from principal, not from the rate, and the rate can add to it. Your own line's numbers depend on the balance, the rate at the transition and the length of the repayment period, all of which the lender discloses in the plan documents.

Balloon structures

Some plans have no amortizing repayment period at all. The draw period ends and the full balance is due, either as a balloon payment or through a refinance the borrower has to arrange. Regulation Z's home-equity-plan rules require the lender to state, in the disclosures given at application, whether the minimum payments will repay the balance and whether a balloon payment may result. That line in the disclosure is worth finding before you sign.

What the disclosures tell you, and what they do not

Under 12 CFR 1026.40, a lender offering a consumer HELOC must give you a disclosure package and the Consumer Financial Protection Bureau's home-equity-line brochure when you apply. The package covers the length of the draw and repayment periods, how the minimum payment is determined in each, the variable-rate features including the maximum rate, and an example of the minimum payment at that maximum rate. It also describes the circumstances under which the lender can freeze or reduce the line, such as a significant decline in the property's value or a material change in your financial circumstances.

What the disclosures do not do is translate the rules into your payment. They show an example balance at the maximum rate, not your balance at the rate you will actually face when the draw period ends. That is the arithmetic you have to do yourself, or with a broker, using the balance you expect to carry into the repayment period.

Managing the transition

Options in general terms

Several tools exist, and which are available depends on the specific program.

• Pay principal during the draw period. Nothing stops you from paying more than interest. A balance that is already declining when the repayment period begins produces a smaller amortizing payment.
• Use a fixed-rate conversion option, where offered. Some programs let you convert all or part of a drawn balance to a fixed rate and a set repayment schedule during the draw period, in exchange for different pricing. Terms, minimums and fees vary by lender.
• Refinance the line before the transition. A new line resets the draw period; a cash-out refinance of the first mortgage can absorb the balance into one amortizing loan. Both depend on equity, credit and the market at the time, none of which are certain years in advance.
• Size the line for the second payment. The most reliable option is to draw only what you can carry as an amortizing payment at the plan's maximum rate. That number, not the interest-only figure, is the honest capacity of the line.

Where owners get caught

The common pattern is a line opened for a renovation, drawn to near the limit, carried interest-only for years because the payment was comfortable, and then converted to an amortizing payment at a higher index than the one in place when the line opened. Each step was reasonable. The combination was not modeled. Investors who fund down payments from a line face the same dynamic, with the added variable that the rental's cash flow, not a salary, may be what services the line.

What to do next

Run the HELOC payment calculator with the balance you expect to carry into the repayment period, not the balance you plan to draw on day one, and look at the amortizing payment for the repayment-period length in your plan. The HELOC program page explains the structure, the documentation paths and the freeze and reduction terms, and the home equity calculator estimates how much line your equity supports. If you are weighing a line against a refinance, HELOC vs cash-out refinance vs DSCR cash-out for investors frames the trade.

The homeowners hub compares the programs for homeowners side by side.

When you are ready, tell us what the line is for and we will show both payments before you commit.