- 7 min read
- Most HELOCs have variable interest rates.
- You may be able to protect yourself from rising rates with a fixed or convertible HELOC.
- Rising rates can spike your payment during the HELOC repayment period.
Need extra cash for a home improvement project or another financial goal? A home equity line of credit (HELOC) provides the ability to liquidate your property's equity in the form of cash.
But HELOCs typically charge variable rates of interest. That means your HELOC rate and what you pay each month can change over the life of your loan. Rising rates can quickly equate to unaffordable payments.
Learn more about how often the interest rate can change on a HELOC. Also, learn how variable HELOC rates compare to the prime rate and how to convert to a fixed interest rate or refinance your HELOC if your lender permits it.
How HELOCs Work
A home equity line of credit (HELOC) is a revolving credit line for which your home is used as collateral to secure financing. A HELOC lets you tap into the equity you've built up in your property. Like a credit card, you are provided access to funds up to a predetermined ceiling. You can withdraw funds during the first phase of the HELOC as often as you like up to your maximum approved borrowing amount.
Your home's appraised value determines how much credit a lender will approve you for. The lender will likely calculate your credit limit by subtracting the balance you owe on your existing mortgage from a percentage of your home's appraised value (such as 70%). Additionally, your lender will scrutinize your creditworthiness based on your earnings, financial obligations, credit history, and collective debts.
Keep in mind that the interest rate on a traditional HELOC is not fixed. Depending on your lender and the terms of your HELOC, you may be given an introductory period during which your interest rate remains fixed. But if not, or after your introductory period expires, you will be charged a variable rate based on current prime rates (plus or minus a margin) that can decrease or increase over time.
Some lenders offer fixed-rate HELOCs or allow you to convert or refinance your traditional HELOC to a fixed-rate HELOC (more on this later).
"If you are considering a HELOC, it's important to fully understand the product and how it works. HELOCs are similar to a credit card, where both have interest rates that may change and balances that can go up or down, depending on how much approved equity you choose to utilize," says Anthony Pellegrino, consumer direct lending manager for Northwest Bank. "They can be an excellent product for someone who needs quick access to funds or for covering projects over time. Having a HELOC in place also provides a great fallback form of funds to cover those unexpected expenses that may pop up in the future."
Understanding the Draw Phase Vs. Repayment Phase
A HELOC has two distinct phases: a draw phase and a repayment phase. A draw period commonly lasts 10 years. You can withdraw money from your equity anytime and as often as desired during the draw phase, up to the maximum amount allowed. Over the draw period, you are only required to make minimum payments on any interest owed – you do not have to repay the principal during this time. If you choose, you can also pay off your outstanding balance in full during the draw phase. And you won't start making interest-only payments until you begin borrowing against your line of credit.
After your draw phase ends, the repayment phase begins. During the repayment phase, you are no longer allowed to withdraw funds. You must pay back your principal and interest in full or over a set period, such as five to 20 years. Suppose you only pay the minimum payment due every month. In that case, you will be required to repay the remaining balance at the end of the term in the form of a balloon payment (a lump sum single payment) or fixed monthly payments.
How Often Can The Interest Rate Change On A HELOC?
The variable interest rates attached to a traditional HELOC can rise or fall depending on a few factors. One is the federal funds rate, which is the rate banks and lenders charge one another for overnight loans. The Federal Reserve sets the federal funds rate. Many lenders also align their HELOC rates based on the prime rate – a benchmark interest rate that is often three percentage points above the federal funds rate. After the Federal Reserve alters the federal funds rate, the prime rate can change accordingly.
Typically, a HELOC variable interest rate will change every month to six weeks, depending on if the rate follows the fed funds rate or prime rate. Your HELOC rate change often occurs at the start of the month, based on prime rates.
The good news is that your lender will inform you in writing when rates may change. This disclosure should be spelled out on your HELOC statement or bill, and you should be able to spot a forthcoming rate change prior to your payment due date. Review the terms spelled out in your signed HELOC documents for more details. Also, inquire with your lender to learn if they have determined a specific minimum or maximum on your variable rate.
What Happens To Your HELOC Payment During The Draw Phase
You're probably wondering: How often can the interest rate change on a HELOC during the draw period? The answer is that, if you have a variable rate HELOC, the interest rate you are charged can change every month or few weeks, as explained earlier.
That means it may be challenging to plan ahead and project your monthly interest-only payments during the draw phase (remember that you only pay interest during this period; you don't have to repay the principal until the repayment phase).
For help in figuring out how much your HELOC payment will be during the draw phase, ample no-cost HELOC calculators are available online. But you can also do the math yourself.
Assume, for example, that your interest rate today is 5%. Your principal balance (the amount borrowed) is $25,000. Simply multiply your current balance by your current interest rate and divide by 12. Here's the math using this scenario:
$25,000 x 0.05 ÷ 12 = 104.17
That means you will pay about $104 interest-only payments on your HELOC this month.
But if you're variable rate jumps to 6.5% two months from now, the math changes. Here, the formula would be:
$25,000 x 0.065 ÷ 12 = 135.42
In other words, you would pay over $135 a month at that time – more than $31 extra per month.
What Happens To Your HELOC Payment During The Repayment Phase
Things get a lot more expensive during the repayment period. That's because you will now be required to repay both principal and interest on your current balance. Again, if you have a variable rate HELOC, what you pay month-to-month will likely change.
Let's take the previous hypothetical where you borrowed $25,000. Assume your repayment period will span 60 months. Imagine your current interest rate charged is 5%. Using an online HELOC repayment calculator, we can determine that you will pay about $472 a month (including interest and principal) until your rate changes again. That's a big jump from the $104 you were paying monthly during the draw phase, even though the interest rate is comparable (5%).
Now imagine if, during your repayment phase, your rate climbs from 5% to 8% a few months later. That means your monthly payments would escalate to roughly $507 – $35 more per month.
Examine a more extreme scenario: You borrow $50,000, and your rate is 5% during the draw phase. You would pay only about $208 monthly until your rate changes again. At 5% during the repayment phase, however, your monthly repayment bill would be over $943. But if rates catapulted to 8%, you would pay almost $1,014 during the repayment period until rates changed again.
How To Shield Yourself From Increasing HELOC Rates
Worried about variable rates changing and becoming unaffordable? You can explore three different options for protecting yourself against rising HELOC rates.
Option #1: Select a fixed-rate HELOC right
A fixed-rate HELOC charges a fixed interest rate for the entire term of the loan. But your lender may assess a higher interest rate for this HELOC than they would for a traditional HELOC. Also, you may end up paying more fees with a fixed-rate HELOC, and the ceiling on what you are allowed to borrow could be less.
Option #2: Convert your traditional HELOC to a fixed-rate HELOC
Your lender may permit you to convert to a fixed-rate HELOC prior to closing on your loan or during the draw phase. Suppose your traditional HELOC includes an initial fixed interest rate phase during the draw phase. In that case, it's wise to convert it before this period ends. Just be aware that your lender may have stricter requirements to qualify for a convertible HELOC.
Option #3: Refinance your traditional HELOC
Instead, you can choose to refinance your traditional HELOC to a new convertible fixed-rate HELOC or a fixed-rate home equity loan, if your lender allows it.
What if I can’t afford my HELOC payment?
If you can no longer afford your HELOC payments, it’s best to reach out to your lender to learn what options may be available to you, per Anthony Pellegrino with Northwest Bank. It may be possible to refinance your loan into a longer-term fixed rate home equity loan or new convertible fixed-rate HELOC.
Are there different rates during the draw period and repayment period?
If you have a traditional HELOC with a variable interest rate, your rate will increase or decrease during both the draw and repayment phases. Your rate will likely be based on prime rates and/or the federal funds rate set by the Federal Reserve. If you have a fixed-rate HELOC, your rate will not change.
Can I convert my existing HELOC to a fixed rate?
Yes. Your lender may allow you to convert your traditional variable-rate HELOC to a fixed-rate HELOC before you close on your loan or during the draw phase.