Downsides of Home Equity Lines of Credit

• The rate is adjustable and tied to prime
• It can go up significantly during periods of inflation
• Rate adjustments can be frequent relative to other ARMs (multiple times per year)
• Higher interest rate caps

There are a number of reasons to steer clear of HELOCs. The main reason being that it’s an adjustable-rate mortgage.

Whenever the Fed moves the prime rate, the rate on your HELOC will change.

Usually it’s only .25% at a time, but the Fed raised the prime rate about 20 times in a row since 2004, pushing the rate from 4% to 8.25%, before it began to move the other way.

Then recently raised rates 11 times from early 2022 to mid-2023, pushing prime up more than five percentage points in the process.

So your interest rate can fluctuate greatly, even if the Fed moves prime in so-called “measured” amounts.

HELOCs generally adjust either monthly or quarterly, depending on the terms specified by the lender.

Check your paperwork so you know what to expect after the Fed makes a move.

Also note that HELOCs don’t have periodic interest rate caps like standard adjustable-rate mortgages, just lifetime caps, so the rate can fluctuate as much as the Fed allows it to, up to 18% in California (it varies by state).

Term of a Home Equity Line of Credit

• Typically begins with a 5-10 year draw period
• Where you can make interest-only payments each month
• Followed by a 10-20 year repayment period
• Where you must pay back principal and interest to satisfy the loan

A HELOC normally has a 25-year term, with a draw period and a repayment period. The draw is typically the first 5 to 10 years, followed by the repayment period of 10 to 20 years.

But it can vary, with some HELOCs offering longer draw and repayment periods to lessen the payment burden. And some shorter draw periods between 3-5 years.

During the draw period, the homeowner can borrow as much as they’d like within the line amount, and can make interest-only payments on the amount drawn upon.

There is usually a minimum payment, just like a credit card.

After the draw period, the borrower must pay off the principal of the HELOC, along with the interest. This period is known as the repayment period.

Typically the loan balance is broken down into monthly payments, but there could also be a balloon payment because of the way the loan amortizes.

Also note that some HELOCs don’t have a repayment period, so full payment is simply due at the end of the draw period. Source