How Interest-Only HELOCs Really Work

HELOCs, or home equity lines of credit, are one type of home equity product commonly offered by lenders. They function much like a credit card, giving you a line of credit to pull from as needed over a certain “draw” period.

In some cases, HELOCs are repaid like traditional mortgage loans—with monthly payments going toward both the interest and principal balance. But interest-only HELOCs only require interest payments during the draw period. Once that period expires, you’ll make larger payments to catch up.

Interest-only HELOCs can make it easier on your pocketbook at the start, but they can also be a financial burden down the line. Not sure if an interest-only home equity line of credit is right for your needs? This guide can help you decide.

In this review:

• What is an interest-only HELOC?
• Pros & cons of interest-only HELOCs
• How to determine if an interest-only HELOC is right for you
• Tips & tricks to make repayment easier as your repayment period nears
• Where to find HELOC lenders

What is an interest-only HELOC?

As its name implies, an interest-only HELOC is a home equity line of credit that only requires payments toward the interest during the initial draw period. Draw periods vary by HELOC, but they’re usually five, 10, or 15 years long.

The amount you owe each month will increase based on the amount you borrow, as with any HELOC, but you won’t have to worry about paying down the principal amount you’ve borrowed until later. This can be helpful if you’re facing limited cashflow during the draw period.

However, the trouble occurs later when your draw period ends. If you have a traditional 20-year HELOC with a 10-year draw period, your interest and principal-and-interest payments will be spread across the full 20 years.

But with an interest-only HELOC, the amount you borrow will pile up over the first decade, and your resulting principal-and-interest payments will eventually have to be made in half the time.

Pros & cons of interest-only HELOCs

There are definitely some advantages to using an interest-only HELOC, especially if you’re in need of quick cash. For one, they come with lower interest rates than most other financial products, including credit cards and personal loans.

Since they require only interest payments at the start, they also reduce the financial burden that borrowing cash puts on your household—at least at the start of the loan.

Finally, HELOC interest is often tax-deductible, as long as you use the funds to improve the value of your home in some form or fashion.

The downsides of interest-only HELOCs are numerous, though. To start, they put your home at risk. And since they often have variable interest rates and changing monthly payments (especially once you draw period ends), they can be a serious threat to your financial stability and your property. 

Another disadvantage is that they’re not as easy to come by as other home equity products. Lenders are generally more hesitant to offer interest-only HELOCs as there’s a higher risk of default once the draw period runs out.

How to determine if an interest-only HELOC is right for you

Interest-only HELOCs have their benefits, but they’re certainly not right for everyone. See below to find out when one of these loans may be best—and when they’re better off avoided.

It may be good for you if…

There’s a number of situations when an interest-only HELOC may be a good option. Generally, if you expect to make more money or have more cash flow once your draw period ends, it could make sense.

Here are some scenarios when interest-only home equity lines of credit could be a good idea:

• You’re spending the funds to increase the value of your home and won’t see a return for a few years.
• You plan to sell your house before the draw period runs out.
• You need low payments now but know you’ll have the finances to cover larger payments later on.
• You have a lot of home equity and want to use the funds toward investments with higher interest earnings.
• You’re flipping a house and want to minimize your payments on the property.
• You need funds for a down payment/closing costs on a new property and plan to sell your old home shortly.
• You’re considering a credit card or personal loan for your expenses, which would cost you more in interest.

It may be bad for you if…

You should probably steer clear of an interest-only HELOC if your income is up in the air (and you’re not confident it will rise in few years) or if you have the funds to make more than just interest payments now.

Interest-only home equity lines of credit will cost you more in interest than traditional HELOCs, so if you can afford the latter, that’s definitely the more affordable option in the long run.

Interest-only HELOCs might also be a bad idea if:

• You’re not good at budgeting or financial planning.
• You don’t have much equity in your home.
• You think your household income will decrease or stay the same by the time your draw period ends.
• You expect your household expenses to rise significantly by your repayment period.

Tips & tricks to make repayment easier as your repayment period nears

Regardless of how well you plan, it can be hard to make those increased payments once your HELOC’s draw period ends. Fortunately, there are a few strategies you can use to ease the burden or even remove it entirely.

Make more than the minimum payment

If you can, start making more than just interest payments when your repayment period is drawing near. Making even a little dent in your principal balance can shave months off your repayment timeline, as well as reduce the interest you’ll pay over time.

Replace your HELOC with a home equity loan

Home equity loans are another product that lets you tap your home equity for quick cash. These loans, though? They often come with lower rates—and fixed rates at that.

If you’re eligible, you may be able to refinance your HELOC into a home equity loan instead. This would mean lower payments and less interest paid in the long haul.

Consider a cash-out refinance

Refinancing into a larger mortgage loan via a cash-out refinance can free up cash and help you pay off that HELOC balance. Depending on where the prime rate is, you may even get a lower rate than your current mortgage has now. That would mean lower mortgage payments to boot.

Downsize your home (or just sell it)

Once your draw period comes to a close, you might consider downsizing your property if the timing is right.

Then, use the profits to pay off your existing loan and the HELOC, and use any leftovers as a down payment on a smaller, less expensive property. This is a great option if you’re nearing retirement or are an empty nester.

Re-up your credit line.

Depending on how much equity you have in your home, there’s a chance your lender may allow you to renew your home equity line of credit.

This would let you keep that lower monthly payment and put off the higher-payment period until later on. A word of warning, though: This only means more interest paid in the long run (and a longer time in debt on the whole).

Consider a reverse mortgage.

If you’re 62 or older, you might consider a reverse mortgage to help you pay off your HELOC balance and fund your retirement.

These mortgages actually pay you (either in a lump sum or monthly payment) to live in your home. They’re a good option if you’re on a fixed income and you need to reduce your monthly costs.

The lender simply pays off the loan balance (plus interest) with the proceeds of the home sale once you leave the property.

Where to find HELOC lenders

Most major mortgage lenders offer home equity lines of credit, though not all have interest-only options. As with any mortgage loan, it’s important you shop around for a HELOC, so make sure you compare customer service, rates, and other factors before making your decision.

Need help choosing the right lender for your interest-only HELOC? Here are our top-rated HELOC lenders.