How Is HELOC Interest Calculated?

A home equity line of credit (HELOC) is one financing option for a significant home project or other large expense. A HELOC allows you to borrow against your home equity. Like a mortgage or home equity loan, your home is collateral for the credit line. 

HELOCs are a popular choice because they often have low interest rates and provide flexible financing. During the draw period—10 years is common—you can borrow from it as needed up to the total of your HELOC and repay it during the repayment period, which can be as long as 20 to 25 years.

HELOCs often have variable rates that change over time, but fixed-rate HELOCs are also available. Here’s some insight into how HELOC rates work and what to know about these flexible financing options.

How are HELOC rates determined?

Two factors determine most HELOC rates: 

1. A benchmark index. Lenders often use the Prime Rate as the index used to set their rates. The prime rate is typically aligned with the federal funds rate, determined by the Federal Open Market Committee.
2. A borrower’s creditworthiness. When determining your HELOC rate, lenders consider your credit, debt, and income. In general, borrowers with solid credit and relatively low debt receive the best rates.

Our recent evaluation of 35 lenders showed some of the lowest HELOC rates ranged from 7% to 8% as of March 2024. However, averages may be higher or lower as you read this, and you may see different rates depending on the lender you choose and your creditworthiness. 

Remember that most HELOCs have two phases: a draw phase and a repayment phase. Your rate will vary depending on the HELOC’s phase. You’ll often receive a variable rate during the draw period, which will usually convert to a fixed rate during the repayment phase. 

Depending on the specific terms of your loan agreement, the benchmark index may be used to adjust the rate during the draw period and fix the interest rate when your HELOC transitions to the repayment phase. 

How does HELOC interest work?

Similar to most loans, you’ll pay monthly interest on the outstanding balance of your HELOC. What’s different is that when you get a HELOC, there are two distinct phases: a draw phase and a repayment phase. Interest works differently in each phase. 

A HELOC works similarly to a credit card during the draw phase. You can borrow funds and repay them as needed. You’ll only pay interest on the outstanding balance. If you don’t have an outstanding balance, then you won’t be charged interest.

Conversely, the repayment phase of a HELOC works the same as a traditional mortgage. The goal is to repay the outstanding balance plus interest over a set repayment term, often 10 to 25 years. Your monthly payment will include principal and interest. 

Like a credit card, you’ll usually pay a variable interest rate on your HELOC during the draw phase. You’ll often pay a fixed interest rate during the repayment phase, but you also have the flexibility to choose a variable rate, just like you can do with a traditional mortgage. 

Generally, a fixed rate is better as you know your cost, especially in a rising interest rate environment. But if you believe interest rates have peaked and are trending lower, then you might want to consider the variable option.

Jim McCarthy, CFP®

Variable rates are usually based on an index like the Prime Rate, +/- a factor. The actual variable rate will fluctuate with the movement in the underlying index. Normally, you would not expect a lot of movement in the index, but as we saw in 2023, interest rates moved up quite sharply throughout the year.

Jim McCarthy, CFP®

How is HELOC interest calculated?

At the most basic level, the HELOC interest calculation is simply a function of your outstanding balance multiplied by the agreed-upon interest rate. Many HELOCs use simple interest to calculate your payment rather than compound interest (where you’re charged interest on top of interest). 

During the HELOC draw phase, simple interest is typically calculated based on the outstanding balance multiplied by the daily interest rate. The draw phase commonly features variable interest rates influenced by market conditions and the borrower’s creditworthiness. 

In contrast, during the repayment phase, the calculation is essentially the same as a traditional mortgage, with the borrower making regular monthly principal and interest payments. Like a conventional mortgage, the interest rate can be variable or fixed, depending on the borrower’s preference.

The interest rate calculation can be more complicated during the draw phase, so we’ll spend more time exploring how this works. 

How HELOC interest is calculated during the draw phase

The HELOC interest calculation during the draw phase hinges on the outstanding balance borrowed from your line of credit. Almost always, HELOC interest rates are variable and tied to a benchmark index rate, which can vary based on market conditions.

Your loan agreement will define how your payments are calculated, including the interest type (simple versus compound) and the interest accrual frequency, such as daily or monthly. Daily interest accrual is common since your HELOC balance may fluctuate as you borrow and repay funds. 

In addition to interest, some lenders may require you to pay a percentage of your outstanding balance with each payment, such as 1% to 4%. If this is needed, it will be defined in your loan agreement. Most HELOCs allow interest-only payments during the HELOC draw period. 

Some lenders calculate the daily interest rate using a 360-day year, which assumes every month has 30 days. Your loan agreement will define how many days are assumed in each year and month for the interest calculation.

While the exact interest calculation will vary depending on the terms of your HELOC, let’s look at a simple illustration of how this might work. 

HELOC interest calculation example

Let’s assume you have a HELOC of $50,000 that’s still in the draw period, and last month’s outstanding balance was $10,000.

We’ll further suppose you’re allowed to make interest-only payments. Your lender uses a simple interest calculation assuming 365 days in a year, last month had 30 days, and your interest rate is 5%. 

Detail	Amount
HELOC credit limit	$50,000
Last month’s outstanding balance	$10,000
Interest rate	5%
Number of days in a year	365
Daily rate	5% / 365 = 0.0137%
Last month’s accrued interest	$10,000 x (30 x 0.0137%) = $41.10
Interest payment	$41.10

In this example, the accrued interest for the previous month would equal $41.10. Assuming you can make interest-only payments on your HELOC during the draw phase, your monthly payment would also be $41.10.

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