How does the HELOC repayment process work?

With inflation is soaring and the cost of borrowing reached multi-decade highsowners are fortunate to have access to a more affordable source of financing: the equity in their home. While interest rates are in effect credit cardpersonal loans and even traditional mortgage refinancing slipped well into the double-digit range, home equity loans And Home Equity Lines of Credit (HELOC) remain relatively cheap, with home equity rates currently fluctuating between 8% and 9%.

This relatively low borrowing cost comes at an opportune time for American homeowners, who have seen immense gains in their home equity levels during the last years. Currently, the average homeowner with a mortgage has $300,000 of equity built up in their home, meaning the typical homeowner has substantial borrowing power through home equity products. And lenders generally allow borrowers to access between 80% and 90% of their home equity, so with $300,000 in average equity, the typical borrower could potentially tap into about $190,000 of that equity.

But even though home equity loans can be a smart financial decision for a variety of uses – debt consolidation, home renovations, major purchases, business investments, etc. – it is important for borrowers to understand the repayment process, especially when using a HELOC. After all, the HELOC repayment structure is unique compared to other common borrowing options.

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How does the HELOC repayment process work?

When you take out a HELOC, you are approved for a revolving line of credit with a set maximum amount, similar to a credit card. This line of credit is secured by the equity in your home.

During the HELOC Draw Period, which generally lasts five to ten years, you can freely borrow from your credit line up to the maximum amount. But you only have to make monthly payments on the amount actually borrowed, not the entire line of credit.

Monthly payments during the draw period are generally interest only. You are not required to repay the principal borrowed during this period. This means that your payments only go toward the interest charges that accrue each month on your outstanding debt. HELOC balance during this time.

Once the drawing period is over, you participate the repayment period, which generally lasts between 10 and 20 years. During the repayment period, you cannot borrow additional funds from your HELOC and you must begin repaying the principal amount borrowed, not just the interest.

Your monthly payments will increase considerably during the repayment period. Instead of paying interest only each month, your payments will go towards paying both interest and principal through fixed amortization payments, similar to a mortgage.

The transition from the interest-only period to the principal-plus-interest period can cause payment shock if borrowers are not prepared to their HELOC payments will increase. In turn, it is important to understand this repayment structure up front and plan for increased costs during the repayment phase.

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Why a HELOC Makes Sense Right Now

Despite the complexities associated with the HELOC repayment process, now is a beneficial time to consider tapping into your home equity through a HELOC for several reasons:

• HELOC rates remain low compared to other borrowing options. At around 9%, HELOC rates are significantly cheaper than credit cards (currently averaging 21% or more) and personal loans (currently averaging more than 12%). And they may make more sense than a cash-out refinance for those who got a low mortgage rate during the pandemic.
• Home values ​​and equity levels have skyrocketed. With the average homeowner having $300,000 of leverageable equity, borrowers have substantial equity accessible through HELOCs or home equity loans.
• Interest rates are currently high, but HELOC rates are variable. So, rather than locking in your long-term interest rate, your rate may change over time depending on the overall pricing environment. This could be a significant benefit if rates fall in the future, which is expected.
• You can borrow flexibly for various uses. HELOCs offer revolving lines of credit that can be used for almost any purpose – consolidate high-interest debt, finance home renovations, invest in a business, pay for college, or make other major purchases.

The essential

For borrowers with sufficient home equity, HELOCs can offer an attractive and flexible source of relatively affordable financing in today’s environment of high inflation and rising rates. But while borrowing against your home equity may be a good option right now if you need to borrow money, it’s still essential to borrow responsibly with a HELOC and have a plan for meet increased payments once the repayment period begins. This way, you can ensure that your HELOC aligns with your overall financial plan and is the option that best meets your needs.