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April 20, 2022

When an Interest-Only HELOC Makes Sense

When faced with an extensive home repair or improvement project (new roof, anyone?), it can seem like saving up enough money to pay for it is impossible.

But a home equity loan can be a smart choice. Yes, you’re borrowing against your home’s value. But you may be using that money for something that will only increase the overall value of your home. And with home values on the rise, you may have more equity than you imagined, so the overall debt burden on your home can remain reasonable.

What is an interest-only HELOC?

You may have heard of a home equity loan. This type of loan is secured against your home’s value, which usually means that interest rates are much lower than other, unsecured types of loans, such as a credit card or personal loan. And depending on your tax situation, you may even be able to deduct the interest on your taxes, just as you do with your primary mortgage. (As always, please consult your tax adviser for advice specific to your situation.)

A HELOC, or home equity line of credit, functions like a standard home equity loan, but you only draw from it as you need it. So, if you’re having your roof done, you would draw a portion for the down payment to the contractor and then draw as much as you need (up to the limit of your line of credit) as the project progresses. So, if your project comes in under budget (not how it usually goes, we know, but it could happen), with a HELOC, you would only borrow what you needed to complete the project.

And with a HELOC, you make payments only on what you borrow. With a lump sum home equity loan, you have borrowed the full amount you asked for, even though you didn’t end up needing all of it, and you’ll be making payments on that full loan amount. As other things come up during the draw period, you could use the remaining credit limit in your HELOC to cover those needs without applying for a new loan.

To break it down even further, with an interest-only HELOC, you only pay the interest during the draw period, typically ten years. During the ten years, you can draw from the line of credit and make payments based only on the interest of what you’ve borrowed. After the ten years, you can no longer draw on the line of credit, and your payments will include both principal and interest. (As a review, the principal is the amount of money you’ve borrowed. This amount may or may not be the same as the amount of your line of credit, depending on how quickly you use the funds.)

So, when does an interest-only HELOC make sense?

If you know you’ll have a series of expenses over a ten-year period, and you’d rather have flexible payments, then this type of loan is a good fit. You will need to meet credit score, equity, and other requirements, just like with any other loan, but you will benefit from much lower interest rates that may also be tax-deductible.

HELOC funds are not limited to how you can use them. Many people use home equity funds to pay for college, consolidate credit cards, and cover unexpected expenses. Still, using them for something other than home repairs or improvements may affect your ability to deduct the interest. And if you default on the line of credit, you do put your home at risk for foreclosure.

You will want to make sure that you can afford the payments once the draw period ends. We can work with you to explore some scenarios of what your payments may be, so you can ensure that your budget will accommodate those payments. And if you want to make principal payments during the draw period, you can. That will help you free up more HELOC funds to use as more projects come up and help you lower the payments once the draw period ends. (The less principal you’ve borrowed, the lower your payments will be.)

The ease with which you can access your HELOC funds without a new loan application is also a significant benefit of a HELOC. As long as funds are available, you can draw from that line of credit when you need to — no need to wait for a loan to be approved and the funds to be disbursed.

Ready to apply for a HELOC? We’ve got all the information about what it takes to get a home equity line of credit and how much you may be able to borrow — plus an easy online application.