It seems like only yesterday when you took out that home equity line of credit (HELOC).
The annual percentage rate (APR) was probably around 3.25 percent – where the prime rate stood from 2008 to 2015. Time flies, and now, if your 10-year draw period is ending, it’s decision time.
“Sooner or later it’s going to have to be paid back,” says Greg McBride, CFA, Bankrate’s chief financial analyst. “And as interest rates go up, it’s going to be like dragging a safe through sand.”
Even if the HELOC’s draw period isn’t ending, odds are the variable rate has risen significantly. As of October 2018, the average nationwide rate for a $30,000 HELOC had risen to 6.22 percent, according to Bankrate data.
Here are three factors you need to consider:
- Know how long your draw period is and when it will go into repayment.
- Avoid surprises by knowing what your principal and interest payment will be when your HELOC goes into repayment.
- Consider your options for refinancing or retiring the loan before the draw period ends.
1. Be aware of when the draw period is expiring
The draw period on a HELOC is usually 10 years. This the time when you can actively withdraw and use the line of credit. You may be able to access HELOC funds via withdrawal, check writing or via a transaction card that uses the HELOC. The draw period may vary depending on your lender. Usually in the draw period, only interest on the amount you’ve drawn is due.
After your draw period, a HELOC usually transitions into the repayment period. In this period, you usually aren’t allowed to draw money and your required monthly payment includes principal and interest.
2. Know what you’ll owe if you enter the repayment period
Determining the principal and interest payment long before you enter the repayment period will help you avoid surprises.
“Even without rising interest rates, that can produce a notable payment shock,” McBride says. “The rising interest rates compounds that issue.”
Principal and interest payments can cause significant change to the family budget. Typically, the repayment period is around 15-20 years.
“In a rising-rate environment, you don’t want to be kicking the can down the road forever on paying back that balance,” McBride says. “Sooner or later, you’re going to have to pay off that debt. And that’s better addressed now before interest rates move higher.”
3. Research your options
- Refinance into another HELOC with a fresh draw: If you utilize this option, see if you can find a HELOC that has a low-APR introductory period. “That can act as a tail wind toward paying down that balance as quickly as possible and being insulated from further rate increases,” McBride says.
- Refinance into a HELOC and utilize a fixed-rate option: This will give you the power to fix your APR on the amount owed, and will still allow you to draw on the remaining funds during the draw period.
- Refinance into a home equity loan: This will make your payments and APR fixed, but you won’t be able to draw money. Assuming you make the scheduled payments, you’ll know exactly when your debt will be paid off.
- Pay off your HELOC: If you have the extra cash, it might make sense to repay your HELOC – or lower the balance by applying additional amounts toward principal. “See if the lender will fix the interest rate on your outstanding balance on your current home equity line and then really put the hammer down on making bigger payments before the draw period ends to minimize the payment shock,” McBride says.
- Roll the HELOC into a mortgage refinance: It may make sense to refinance the HELOC – and a first mortgage – via a mortgage refinance. Closing costs and fees may be higher on this option, so compare fees from multiple lenders before deciding. In certain instances, a cash-out refinance, may also be an option to research.