Wondering how much you have to pay each month for a home equity line of credit? This financing works differently from other choices, so you won’t have to pay much in the beginning. However, it’s important to know your minimum monthly payment once the draw period ends and those payments become necessary to keep your home and rebuild equity. Understanding how HELOC payments get calculated will help you allocate them in your budget.
How Do HELOC Payments Work?
HELOC payments do not start when you obtain the line of credit. You only have to repay the principal with interest once you borrow against the line of credit, and even then, you don’t have to pay it back right away. HELOCs have a similar payment structure as credit cards, and they have variable rates. HELOCs typically have lower interest rates than credit cards and other financial products since a credit line uses your home as collateral.
How HELOC Payments are Structured
When you take out a credit line against your property, you have two stages of repaying the debt. The first one is the draw period, which offers more flexibility, followed by the repayment period.
Draw Period
The draw period is when you can borrow money against the home equity credit line without having to pay back the principal. Instead, you only have to repay the interest each month. The draw period typically lasts 5-10 years, but you should still repay the balance when possible instead of stopping at interest. This is because the interest rate never sleeps during the draw period, and any balance on your credit line will compound because of the APR.
Repayment Period
The repayment period is when you must pay off the line of credit. After the draw period, the unpaid balance turns into an installment loan. You have to make monthly payments over a predetermined timeframe. Most repayment periods last 5-20 years, but each lender is different. You can chip away at your balance during the draw period to minimize monthly payments or seek a longer term on your repayment loan to have more room in your budget.
What is the Formula to Calculate a HELOC Payment
The principal, interest, and length of the loan impact your monthly payments. In addition, you will owe the amount you borrow against the HELOC. For instance, if you take out a $700,000 home credit line and borrow $500,000, you only owe $500,000 for the loan.
Consumers can use the following formula to calculate this two-step formula to calculate their monthly HELOC payments:
A = P(1 + rt)
A = Principal + Interest
P = Principal
R = Rate
T = Time (in years)
Then, take the total amount (A) and divide it by the number of months.
Monthly payment = A / # of months
Example: What is the Monthly Payment on a $500,000 HELOC
Wondering how much you would owe on a $500,00 HELOC? The principal, interest, and loan term play decisive roles in determining your monthly payment. In this example, assume the $500,000 HELOC has a 6% interest rate and a 10-year term. We will use the first formula to determine the total payment, including interest and then the second formula to identify the monthly payment.
A = P (1 + rt)
A = $500,000 (1 + ( 0.06 ) ( 10 ) )
A = $500,000 (1 + 0.60)
A = $500,000 * 1.60
A = $800,000
The total payment will be $800,000 for a $500,000 HELOC with a 10-year term and a 6% rate.
The final step is to divide this total by the number of months in the loan term. For example, a 10-year loan term has 120 months. You can use this simple formula to discover the monthly payment:
Monthly Payment = A / # of months
Monthly Payment = $800,000 / 120
Monthly Payment = $6,667/mo
It’s important to consider how the interest rate plays a role in your monthly payments. If the interest rate were 5% in this example, the total amount and monthly payments would be $750,000 and $6,250, respectively. Therefore, you will save $417/mo if you get a 5% rate instead of a 6% rate.
However, if you had an 8% interest rate instead of a 6% rate, your total amount and monthly payments would be $900,000 and $7,500, respectively. You would owe an additional $100,000 and pay an extra $833/mo if you had an 8% rate instead of a 6% rate. These gaps demonstrate the importance of continuing to build your credit over time. A high credit score can trim a few percentage points off the interest rate and save you hundreds of dollars per month.
Should You Get a HELOC?
A home equity line of credit gives you more financial flexibility without the immediate commitment to pay off the loan. The line of credit drawing period only requires interest payments in the beginning, and it can be 5-10 years before you have to make monthly payments on the HELOC balance. We have highlighted some of the advantages and disadvantages of getting a HELOC.
You May Get Lower Interest Rates
HELOCs typically come with lower interest rates than home equity loans and personal loans. As demonstrated in the previous calculation, a lower interest rate can save you hundreds of dollars per month when the repayment period begins.
You Don’t Pay Interest Right Away
While you will owe interest the moment you take out an installment loan, you don’t pay interest on a credit line until you borrow money against it. This gives you time to assess your financial needs and avoid borrowing too much money.
Generous Draw Period
You won’t have to pay much money each month during the draw period. You can borrow large sums of capital with low monthly payments. This flexibility gives a homeowner enough time to use funds to cover expenses and build up reserves for the repayment period. You can also repay the balance during the draw period, so you won’t have to worry about the loan conversion. Repaying during the draw period also gives you the option to reuse the line of credit. Some borrowers who repay a loan may need to take out an additional loan and incur an additional origination fee for the second loan. You only pay these fees once for a line of credit that you can replenish and reuse for the length of the draw period.
Your Home Becomes Collateral
A HELOC turns your home into collateral. There are significant risks if you fall behind on payments, but you can stretch out your loan to minimize your monthly payments. HELOCs give you multiple years to strengthen your finances before the draw period gives way to the repayment period. Any loan involving collateral increases the risk for the borrower, but these loans typically have lower interest rates, and in the case of a HELOC, you have more time to anticipate the loan’s repayment period.
