The Draw Period
During the draw period (typically 5 to 10 years), you can access funds up to your credit limit at any time and make interest-only payments on the amount drawn. The interest rate is usually variable, tied to the prime rate plus a margin, so payments fluctuate as the prime rate changes.
The Repayment Period
When the draw period ends, the HELOC closes to further draws and enters the repayment period (typically 10 to 20 years). You repay the outstanding balance with fixed monthly principal-and-interest payments. The shift from interest-only to principal-and-interest often results in a "payment shock" -- a significantly higher monthly obligation that can strain cash flow.
HELOC Interest Rate Risk
Most HELOCs are variable-rate products. If the prime rate rises significantly, your interest-only payments during the draw period increase, and repayment period payments will be based on whatever rate is in effect when repayment begins. Model the impact of a 2 to 3 percentage point rate increase before drawing heavily on a HELOC.
Tax Deductibility
Under the Tax Cuts and Jobs Act of 2017, HELOC interest is deductible only when the proceeds are used to buy, build, or substantially improve the home that secures the loan. Interest on HELOC proceeds used for other purposes is not deductible. Consult a tax professional for guidance on your specific situation.
A Worked Example
On a $450,000 home with a $250,000 mortgage balance, equity is $200,000. At an 85% CLTV cap, the maximum combined borrowing is $382,500 -- minus the $250,000 mortgage, leaving up to $132,500 available through a HELOC. Drawing $40,000 during a 10-year draw period at a variable 8.5% costs about $283/mo interest-only; once repayment begins on a 15-year amortization at the same rate, the payment rises to roughly $394/mo.
Common HELOC Mistakes
Treating the credit line like a savings account. Every dollar drawn accrues interest immediately and must be repaid -- it is debt, not found money.
Not planning for the repayment-period payment jump. As shown above, the shift from interest-only to principal-and-interest can meaningfully raise the monthly obligation -- budget for it well before the draw period ends.
Frequently Asked Questions
Can my HELOC limit be reduced after I open it? Yes -- lenders can reduce or freeze a line if home values drop significantly or if your financial situation changes materially during the draw period.
What happens if I don't use the full credit line? Nothing -- you only owe interest on the amount actually drawn, not on your full approved credit limit, though some HELOCs charge a small annual or inactivity fee.