What Does it Mean When a Home Loan Has a Draw Period?

by Mallory Malesky
Drawing from a HELOC can help with other dreams, like running a business.

The mortgage industry makes up a large sector of the United States economy. Banks and lenders offer dozens of different types of mortgage loans to consumers to meet specific financial needs. One specific type of mortgage, a home equity line of credit, allows homeowners to borrow, or draw, from the credit line when they need cash.

Equity

Buying a house is usually considered a good investment because most of the time the property's value will increase -- although there is certainly no guarantee of this. An increase in the home's value combined with paying down the mortgage balance over time creates equity. Your equity is simply the home's fair market value minus the unpaid loan amount. As a homeowner you can borrow your equity by taking out a home equity loan.

Home Equity Line of Credit

Home equity lines of credit, or HELOCs, are available to qualified homeowners with equity in their homes. A HELOC is a loan, generally subject to the same basic approval criteria as your original mortgage loan. However, a lump sum of money is not disbursed after the loan is approved. The HELOC works similarly to a credit card: you use it when you need it. With this type of loan, you'll have a set spending limit. Most lenders will only allow you to borrow a certain percent of the equity, such as 85 percent.

Draw Period

The terms and conditions of the HELOC also describe the draw period and the repayment period. The draw period is a set time frame, such as 5 or 10 years. During this time you can use the credit as you wish. When the draw period is over, you will no longer have access to the funds even if you haven't reached the maximum spending limit. Some lenders may allow you to extend the draw period.

Payments

The payment structure of your HELOC loan will depend on the lender. Some require interest-only payments during the draw period. Others have a set minimum payment with the option to pay more, just like a credit card. Paying down the balance frees up the funds to be used again. After the draw period is up, your permanent payment plan begins. The new payment structure includes both interest and principal payments. However, you only pay back the amount of money you actually used during the draw period. For example, your spending limit might be set at $25,000, but if you only used $10,000, you'll only pay back the $10,000 plus interest.

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