How the Draw Period Works
The draw period is the first of two phases in a revolving line of credit. During this stage, which typically lasts from five to ten years, you can withdraw money as needed up to your approved credit limit. Common ways to access funds include writing special checks, using a linked card, or transferring money to your checking account.
As you repay the borrowed amount, your available credit is replenished, allowing you to borrow again—a feature known as revolving credit. A key characteristic of the draw period is that minimum monthly payments are often interest-only. While this keeps initial payments low, the principal balance does not decrease unless you make additional payments.
The Two Phases of a Line of Credit
- Draw Period: This is the active borrowing phase. You have the flexibility to draw funds, repay them, and draw again. Minimum payments are typically calculated based on the interest accrued on your outstanding balance.
- Repayment Period: Once the draw period concludes, you enter the repayment period. You can no longer borrow from the line of credit. The outstanding balance is converted into an amortizing loan, and your monthly payments are recalculated to include both principal and interest. These payments are significantly higher than the interest-only payments, and the loan must be paid off over the remaining term (often 10 to 20 years).
| Feature | Draw Period | Repayment Period |
|---|---|---|
| Borrowing | Can borrow, repay, and re-borrow funds. | Cannot borrow new funds. |
| Payments | Often interest-only on the outstanding balance. | Includes both principal and interest. |
| Payment Amount | Typically lower and varies with the balance. | Higher and structured to repay the loan by a set date. |
| Primary Goal | Provides flexible access to funds. | Focused on paying off the remaining balance. |
Example of a HELOC Draw Period
Imagine you are approved for a $75,000 Home Equity Line of Credit (HELOC) with a 10-year draw period and a 20-year repayment period.
- Years 1-10 (Draw Period): In the first year, you draw $25,000 for a home renovation. Your minimum monthly payment is only the interest on that $25,000. Two years later, you pay back $10,000, reducing your balance to $15,000. Your available credit increases back to $60,000 ($75,000 limit – $15,000 balance). You can continue this cycle of borrowing and repaying for 10 years.
- Years 11-30 (Repayment Period): At the end of year 10, your draw period ends. Let’s say you have an outstanding balance of $40,000. You can no longer access funds. Your lender recalculates your payment to pay off the $40,000 principal, plus interest, over the next 20 years. This results in a substantial increase in your required monthly payment.
Key Considerations for Borrowers
The end of a draw period can lead to “payment shock” if you are unprepared for the higher payments. It is your responsibility to know your loan’s terms.
- Interest Rates: Most lines of credit have a variable interest rate, meaning your interest-only payments can rise or fall.
- Plan for Repayment: Avoid borrowing the maximum amount if you cannot afford the fully amortized payments later. Consider making extra payments toward the principal during the draw period to reduce your balance before the repayment phase begins.
- Collateral: A HELOC is secured by your home. Failing to make payments during either the draw or repayment schedule can put your home at risk of foreclosure.
As noted by the Consumer Financial Protection Bureau (CFPB), it is crucial to understand the terms and future payment structure before taking on a HELOC.
Frequently Asked Questions
Q: Can you extend a draw period?
A: Typically, the draw period cannot be extended on an existing line of credit. You may be able to refinance into a new HELOC, which would start a new draw period, but this requires a new application and credit approval.
Q: What happens if you don’t use the line of credit during the draw period?
A: If you never borrow from the line of credit, you will not owe any principal or interest. However, check your agreement for any potential annual fees. At the end of the draw period, the unused line of credit simply closes.
