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Dr. Don Taylor, CFA, Bankrate.com advice columnistHow does this HELOC thingy work?

Dear Dr. Don,
I took out what I thought was a home equity loan but now understand it is a home equity line of credit. Do I need to pay on the principal now? I thought the bank was taking payments out of my checking account and it is just for interest. At this rate, when do I start paying on the principal?

Thank you,
-- Connie Compounding

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Dear Connie,
A home equity line of credit, or HELOC, at least in the early years of the loan, has monthly payments that are interest-only. You can make principal payments on the loan by adding an additional amount to your monthly payment. It's a good idea to keep track of these additional principal payments to make sure the lender is correctly adjusting your outstanding loan balance.

Since a HELOC is a line of credit, you may have had a minimum draw requirement on that line when you closed on the loan. There is also the possibility of a prepayment penalty if you pay down the loan balance too aggressively. Since you originally thought you had a home equity loan and not a HELOC, my guess is that you took out a substantial draw at closing and any minimum draws or prepayment penalties won't be an issue with you, but you do want to either review your loan documents or talk to your lender.

Some HELOCs have balloon payments, meaning that your monthly payment continues to be interest-only until, at maturity, you pay off the outstanding principal balance. Other HELOCs are structured so that after an initial interest-only period, the loan becomes self-amortizing, meaning that the monthly payment becomes large enough to cover both interest expense and the reduction of principal balance over the remaining term of the loan.

If you have a HELOC that is interest-only in the first 10 years, and self-amortizing in the second 10 years, you'll have the loan paid off at maturity, 20 years from now, unless you pay it off sooner.

Some HELOCs are structured so they can be converted into a fixed-rate home equity loan. If that was your original intent, you may want to talk to your lender about whether they offer a conversion feature.

To ask a question of Dr. Don, go to the "Ask the Experts" page, and select one of these topics: "financing a home," "saving & investing" or "money."

Bankrate.com's corrections policy -- Posted: July 18, 2006
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NATIONAL OVERNIGHT AVERAGES
$30K HELOC 4.36%
$50K HELOC 4.06%
$30K Home equity loan 5.07%
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