You don’t expect your mortgage to expire, but HELOCs do have an expiration date. It’s more like an end of the draw period and the start of higher payments. There are ways around it, though. You aren’t stuck with the higher payment no matter what. You have options. But, you have to work to get them. We discuss how below.
How the HELOC Draw Period Works
First, let’s look at the basics of a home equity line of credit. You apply for a specific loan amount. The lender processes it like any other mortgage application. It closes like any other loan as well. This is where the differences begin, though.
At the closing, you’ll receive your funds in one of a few ways:
- A check for the lump sum amount of your line of credit
- A form to request a checkbook or ATM card to access the funds
- Funds disbursed by the closing agent to pay off the debts you designated during loan processing
It depends on how you plan to use the funds. If you need the money to pay bills off and it’s a requirement of the loan, the closer will handle the disbursement. If the money is just for you to use as you need, you’ll receive checks and/or an ATM card.
No matter how you take the funds, you have access to the line for a period of 10 years. It works just like a credit card during that time. You use the funds and your available credit decreases. As you pay the principal funds back, your available credit increases. This goes on for 10 years. At the end of those 10 years, you cannot draw from the line any longer.
Your payment will change at that time too. We discuss this below.
Making HELOC Payments During the Draw Period
The draw period is the time when you can use and reuse your funds. The minimum required payment during the entire 10 years is just interest. Again, this is the minimum required. It doesn’t mean you can’t make a higher payment.
If you want to be able to reuse the funds down the road, you have to knock the principal balance down. It’s the same as it is for a credit card. Once you max out your credit card, you can’t use it. If you pay the balance down, though, the funds become available again.
There’s another advantage of making more than the interest payment, though. It will cost you less in the long wrong. If you just make minimum interest payments, you never touch the principal. This means you continually pay interest on the same or higher principal balance. The longer this money is outstanding, the more money you pay in interest. If you knock the balance down, though, it will cost you less interest in the end.
Making HELOC Payments After the Draw Period
Once the draw period ends, you are in for some payment shock. You no longer just pay interest. The principal becomes due. The lender will amortize the remaining principal balance over a 20-year period. Depending on the terms of the loan, you may have a variable rate on the balance as well.
The payment could be much higher than your interest only payment. If you don’t plan accordingly, this could cause some financial stress. During this period, you don’t have the option to make the lower interest only payment. The loan requires installment payments over the next 20 years at which time it is then paid off in full.
Getting Around a HELOC’s Expiration
Luckily, there are ways around the HELOC’s expiration. Whether you can’t afford the higher payment or you still need access to the funds, you can refinance. You aren’t stuck with the same loan even after the draw period.
You can go about this a few ways:
- Refinance into another HELOC – If you qualify, you may refinance into another HELOC. Essentially, this resets the clock, giving you another 10 years of interest only payments. Use this to your advantage, though. Don’t make the minimum payments. Pay as much as you can each month. This way when it re-amortizes in 10 years, you will have a much lower balance and payments that are more manageable.
- Refinance into a home equity loan – There’s a difference between a home equity line of credit and a home equity loan. The latter is a fixed rate and closed-end loan. You can’t reuse the funds. You have the same payment for the entire term.
- Refinance with a cash-out mortgage – If you have great credit, you may get a cash-out loan as your 1st You can then pay off the HELOC with the proceeds of the loan. The benefit is the lower interest rate and possible tax write offs for the interest you pay.
The Bottom Line
Make sure you understand the fine print on your HELOC. The expiration date and draw period are two important factors you must understand. If you are unsure about how the loan operates, talk to your lender. Ask specific questions about drawing funds and the future repayment options.
The last thing you want is an unpleasant surprise 10 years down the road. Once you do take out a HELOC, plan ahead. Around 6-12 months before it expires, talk to your lender. See what options they have for you to refinance the loan. Chances are they will want to keep your business and will try to help you make the payments affordable.
If not, shop around. Find a lender that offers affordable terms so that you don’t get in over your head. The HELOC can be a great loan as long as you use it right!