If you want money to cover a major expense in 2024, a good option is an interest-only home equity line of credit (HELOC). People love the interest-only HELOC because it has a revolving credit line based on your home’s equity, and the money can be used for anything from paying for college tuition to credit card bills or home renovations.
Overview of Interest-Only HELOC
An interest-only home equity line of credit refers to the first few years of a HELOC, where you only pay interest on the money borrowed. The principal is paid back after the draw period on the HELOC ends – usually after 10 years. The interest-only period on a HELOC is frequently available but you may not qualify for interest-only payments if you have a low credit score.
You can usually borrow between 80% and 85% of your home’s value with a HELOC. Your loan-to-value is determined by adding up what you owe on your first mortgage with what you intend to borrow with the HELOC.
HELOCs Offer Low Interest Only Payments
The interest rate on the HELOC is based on a margin that the mortgage lender determines based on your FICO score, plus the prime rate.
The rate on an interest-only HELOC is variable and can change as often as every month.
So, the rate you get on your HELOC when you close the loan could go up or down.
However, many HELOCs have a fixed rate for the first few months or year of the loan.
In 2024 as in the past two years, interest rates have been elevated by the Federal Reserve to fight inflation.
This has made the interest rates on HELOCs increase, like everything else.
However, many interest-only HELOCs are available today in the 9% range, which is still a low rate when compared to credit cards and personal loans.
How an Interest-Only HELOC Works
The first five or 10 years of the HELOC are referred to as the draw period. This is when you can pull money from the line of credit. Lenders often allow you to make interest-only payments during the draw period. You also can pay back principal if you like, but it often isn’t required.
When the draw period is over, you cannot borrow money from the HELOC anymore. You also cannot make just interest-only payments. Rather, you will need to pay interest and principal during the repayment period. The repayment period can last between 10 and 20 years. The repayment period terms vary by the lender and program.
Your lender will establish a payment schedule that amortizes the loan as you repay. The principal will be slowly paid down, and will be paid off at the end of the loan term.
When Is an Interest-Only HELOC the Best Move for You?
If you get a HELOC, you may be able to make lower payments in the draw period by only paying interest. This can be beneficial for the following reasons:
Flexible Payments
With a draw period of five or 10 years, you may be able to pay only interest for some or all of this time, depending on your needs. For example, if you have your hours cut or lose your job, you could make interest-only payments temporarily. You could use the money you aren’t using for principal payments for other things, such as living expenses.
Lower Interest Rate
A HELOC offers a lower rate than most other options on the market in 2024. You can pay a lower rate than other loan options, plus only pay interest for as long as five or 10 years.
However, making interest-only payments has risks. First of all, you don’t know what the rate will be years in the future when you have to pay back the principal. Even the best HELOC interest rates come with a variable interest rate. In 2024, there are signs the Fed may begin to cut rates as inflation cools, but there isn’t any guarantee. You could end up paying a much higher rate, although most HELOCs come with a maximum interest rate.
Second, the longer you owe loan principal, the more interest you pay. You will always save money in the long term by paying interest and principal payments from the beginning. Verify the HELOC closing costs when you are shopping lenders.
Financing Home Improvements
Making interest-only payments temporarily can help when doing home renovations that take a lot of time and money.
Paying For College Tuition
If you have kids in college and use the HELOC money for tuition, it also can help your finances to make interest-only payments while they are in school.
What Happens When the HELOC Draw Period Ends?
You can use your interest-only HELOC for only so long. Eventually, the draw period will end and you’ll need to start paying interest and principal. About a year before the draw period ends, you should look at the principal owed, your current rate, and whether the rate is likely to go up or down.
Next, contact your mortgage lender to find out what fully amortized payments will be when the draw period ends. You should look at the worst-case scenario and determine how high payments could go if the maximum rate happens. Take a look at your overall income and expenses to ensure you’ll have the cash to make your principal and interest HELOC payments.
If you have a good credit score, you could refinance the HELOC into a fixed rate product, such as a cash-out home equity loan or refinance.
Summary on Interest Only HELOC Lines of Credit
One of the best ways to borrow a lot of cash in 2024 is to use an interest-only HELOC. Interest rates have risen considerably since COVID. Credit cards can have rates over 20%, and cash-out refinances may not make sense if you have a lower rate on your mortgage than current rates.
An interest-only HELOC offers a competitive interest rate in the range of 9% or 10% in many cases. Plus, you may be allowed to make interest-only payments for some or all of the draw period. This affordable option can get you the money you need now and keep the monthly payment reasonable. If you have questions about interest-only HELOCs, our loan professionals can answer them today.
Home Equity Mart has created a marketplace for homeowners to shop home equity loans and credit lines. We will help you compare lenders that offer a wide range of second mortgage products including fixed rate home equity loans and interest-only home equity lines of credit for financing home improvements, consolidating debt and much more. Let HEM connect you with competitive lenders who can meet your financing needs.