A home equity line of credit allows you to access a portion of the equity that you have built up and use those funds for a variety of purposes. For instance, you can use a HELOC to pay off credit card bills, make home improvements or fund another large purchase. If you’re thinking about taking out a home equity line of credit, it’s important to understand how the payments are calculated so you can make sure that they will fit your budget.
How a Home Equity Line of Credit Works
With a home equity line of credit, you can access funds when you need them and use your house as collateral. In some ways, a HELOC works like a credit card. You get a line of credit that’s based on the amount of equity you have. You can use as much or as little of your available credit as you want, either at one time or at several times.
Since the interest rate on a home equity line of credit is set based on an index, your interest rate can rise or fall from month to month. That means that even if you don’t make any additional purchases, your required payments might increase. A HELOC generally has a lower interest rate than a credit card.
When and How Much You’ll Have to Pay
A HELOC differs from a credit card in that it has a draw period when you can use your line of credit. The draw period is usually 10 years.
Many lenders require borrowers to make monthly payments during the draw period. In some cases, those payments are just enough to cover interest charges, but sometimes lenders require borrowers to make payments that cover a portion of the principal balance during the draw period.
After the draw period ends, you will enter the repayment period, which is usually 20 years. During that time, you will have to make regular monthly payments and won’t be allowed to use more equity to make purchases. The amount you will have to pay each month will depend on the amount of credit you have used and your interest rate.
Your balance will go up or down depending on whether you make additional purchases and how much you pay each month toward your outstanding principal. If you pay off your principal balance quickly, you will be able to save money by limiting the amount you’ll have to pay in interest charges.
