Overview

A home equity line of credit (HELOC) blends the flexibility of a credit card with the lower rates of mortgage debt. Two features define most HELOCs and determine your cost: the draw period (when you can borrow) and the repayment period (when you must repay principal and interest). How interest is calculated during the draw period and afterward drives monthly payments and long-term cost. This article explains the mechanics, shows numerical examples, highlights traps I’ve seen in practice, and points to resources for comparison-shopping and protection.

How draw periods typically work

  • Length: Most HELOC draw periods fall between 5 and 10 years, although some lenders offer shorter or longer terms. After the draw period ends you enter the repayment period, which often lasts 10–20 years (CFPB; Bankrate).
  • Access: During the draw period you can borrow repeatedly up to your credit limit. You may get a checkbook, debit card, or online transfers to access funds.
  • Payments during the draw period: Many HELOCs allow interest-only payments on outstanding balances during the draw period, though some require partial principal payments. Interest-only lowers early payments but delays principal reduction, which increases later payment amounts.

How lenders calculate interest

  • Index + margin: Variable-rate HELOCs are priced as an index (commonly the prime rate, or increasingly SOFR-based indexes after the LIBOR phase-out) plus a lender margin. The margin is a fixed amount the lender adds to the index to determine your variable rate (Bankrate; Investopedia).
  • Daily accrual, monthly billing: Most lenders calculate interest daily on the outstanding balance (average daily balance or actual daily balance) and bill monthly. That means if you draw $10,000 for half a month and pay it off, you only owe interest for the days the money was outstanding (CFPB).
  • Rate caps and floors: HELOC contracts commonly include periodic rate adjustment caps and lifetime caps to limit how much the rate can change in a given period or over the life of the loan; there may also be a floor (minimum rate). Check disclosures for these protections.

Common examples and math (real numbers)

  • Interest-only example

  • Scenario: $20,000 outstanding; APR = 6.00% (variable). Interest-only monthly payment = principal × APR/12.

  • Calculation: $20,000 × 0.06 / 12 = $100.00 per month. You pay interest only; balance stays $20,000.

  • Transition to repayment (amortizing) example

  • Scenario: At the end of the draw period you owe $20,000 and the lender requires full amortization over 15 years at the same 6.00% APR.

  • Monthly payment formula (standard amortizing payment): P = r × PV / (1 – (1 + r)^-n), where r = monthly rate, PV = loan balance, n = number of months.

  • Calculation: r = 0.06/12 = 0.005; n = 15×12 = 180.

  • Payment ≈ 0.005 × 20000 / (1 – (1.005)^-180) ≈ $168.77 per month.

  • Payment shock: Compare $100 (interest-only) to $168.77; the borrower’s payment rises 69% in this example even with the same APR.

  • Shorter repayment period (bigger jump)

  • If amortized over 10 years instead (n = 120), payment ≈ $222.14 per month — more than double the interest-only payment.

Why payment shock happens

  • Interest-only periods preserve liquidity but don’t reduce principal, so entering amortization forces principal repayment plus interest.
  • Variable rates add uncertainty: if rates rise during the draw period, the interest-only payment is already higher and the amortizing payment later will be even larger.

Index selection after LIBOR and what it means

LIBOR’s phase-out changed benchmark use across markets. Many HELOCs historically tied to the prime rate; lenders have also migrated toward SOFR-linked products or other indexes. The practical takeaway for borrowers: read the rate-disclosure language to know which index applies and how often your rate may reset (Bankrate; Investopedia).

Key contract terms to check before you sign

  • Draw period length and repayment term.
  • Whether interest-only payments are permitted and whether they’re mandatory or optional.
  • Index and margin (what index sets your rate and how large is the margin).
  • Adjustment frequency and caps (how often and by how much the rate can change periodically and over the loan’s life).
  • Fees: application, appraisal, annual, inactivity, or early termination fees (see “Hidden Costs in HELOCs” below).
  • Conversion options: some lenders allow converting outstanding balances to a fixed monthly payment or fixed-rate loan (see HELOC Conversion Option).

Common borrower mistakes I’ve seen in practice

  • Treating a HELOC like a long-term mortgage: Using interest-only payments to fund ongoing consumption without a plan to reduce principal risks a large payment later.
  • Assuming rates won’t rise: With variable-rate HELOCs, a low-interest environment can change quickly; a borrower who budgets for interest-only payments may be unable to absorb a higher amortizing payment.
  • Ignoring fees and suspension triggers: Lenders may freeze or reduce access if property values fall or your credit weakens. Read the suspension and freeze conditions in your contract (see HELOC Suspension Conditions and HELOC Freeze Notification glossary pages).

How to reduce risk and lower total cost

  • Make principal payments during the draw period: Even small principal reductions lower future amortizing payments.
  • Build an emergency fund for the end-of-draw transition: Save to cover the first several months of higher payments in case rates or required amortization change.
  • Negotiate conversion or refinancing language: Ask whether the lender offers a conversion to a fixed rate or a fixed-payment option when the draw period ends (HELOC Conversion Option).
  • Compare products: Use disclosures to compare margins, caps, and fees across lenders.

When to consider other options

  • If you need long-term fixed payments, consider a home equity loan or a cash-out refinance instead of a HELOC (see our comparison: Home Equity Options: HELOC vs Home Equity Loan vs Reverse Mortgage).
  • For one-time projects where you’ll repay principal quickly, a HELOC’s flexibility can be ideal. For long-term borrowing, a fixed-rate product may be safer.

Fees and fine print (what often gets missed)

Many borrowers focus narrowly on the advertised rate. Watch for:

  • Annual or maintenance fees.
  • Transaction fees for draws or checks.
  • Appraisal and closing costs.
  • Early termination or inactivity fees.
    A deeper dive on these hidden charges is available in our glossary entry Hidden Costs in HELOCs: What Borrowers Miss.

Real-world planning checklist (7 points)

  1. Confirm your draw period length and repayment schedule in writing.
  2. Identify the index, margin, adjustment frequency, and caps.
  3. Learn whether the lender allows interest-only payments and whether paying principal is optional.
  4. Ask how interest is calculated (daily accrual vs average daily balance) and read the billing statement example (HELOC Billing Statement Breakdown).
  5. Project payments under several scenarios: stable rates, +200 bps, and amortization over remaining term.
  6. Consider making principal payments during the draw period to lower future amortization.
  7. Keep documentation of draws and payments; monitor property values and your credit.

Frequently asked operational questions

  • Does a HELOC charge interest on my total limit or just the amount I use?
    Lenders charge interest only on the outstanding drawn balance, not the unused portion of your credit line (CFPB).

  • Is HELOC interest tax-deductible?
    Under current federal tax law, interest on a HELOC is deductible only when the borrowed funds are used to buy, build, or substantially improve the home securing the loan and subject to limits on acquisition indebtedness. Check IRS Publication 936 and consult a tax professional for your situation.

  • Can my lender freeze or reduce my credit line during the draw period?
    Yes. Lenders can freeze or reduce access if they detect a material decline in your property value, creditworthiness, or for other contract-specified reasons. Read your disclosure and state laws may add consumer protections (CFPB glossary pages on HELOC suspension and freeze conditions).

Additional resources and citations

Internal links (for deeper reading on related topics)

Professional perspective and closing advice

In my 15 years advising homeowners, I’ve found HELOCs are excellent for planned, short-to-medium term needs like staged renovations or bridging timing gaps — but they require active management. Treat a HELOC as a hybrid: a flexible credit line with mortgage-level consequences. Plan for the end of the draw period, stress-test payments under higher-rate scenarios, and prefer products that let you convert to a fixed payment if you need certainty.

Disclaimer

This article is educational and does not constitute individual tax, legal, or investment advice. Loan terms vary by lender and state; consult your loan officer, a mortgage attorney, and a tax professional for guidance tailored to your situation.