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

Original post by Ciaran John of Demand Media

When you take out a home loan, the loan proceeds are often disbursed immediately after the loan closing and you receive your share of the proceeds in the form of a lump sum payment. However, many financial institutions offer home loans from which you do not receive a lump sum payment. Instead, the lender provides you with access to a line of credit during a draw period.

Two Phases

Home equity lines of credit, like all mortgage loans, have a term time and you must pay the loan back in full by the end of the term. However, lenders divide loan terms on HELOCs into two distinct sections: a draw period and a repayment period. The draw period may last for up to 15 or 20 years, during which time you can draw on the available line of credit as and when you need to. When the draw period ends, you enter the repayment period, during which you no longer have access to the line but must repay the debt.

Payments

During the repayment period you only have to make payments if you actually have a balance on your line of credit. Typically, you only have to make a monthly interest-only payment, although you can usually pay the entire line off at any time. Some lenders require you to keep a balance on the line of credit for a certain period of time and you may pay an interest penalty if you pay it off early. When the draw period ends, you begin to make principal and interest payments that your lender structures so that you have paid the loan off by the end of the repayment term.

Interest Rate

Lenders have to keep money on hand so that you can access funds on your line of credit but since the lender has no way of knowing when you plan to use the funds, most lenders write HELOCs with variable interest rates. This means the lender can charge you a rate based upon the prevailing interest rates at the time you draw on the line, as opposed to the rate at the time that you took out the line of credit. HELOCs usually have rate floors and caps, which mean that your interest rate cannot fall below a certain level but neither can it rise above a certain rate.

Uses

Some people establish HELOCs with the intention of only drawing on funds during an emergency. Since it can take weeks or months to process a loan application, people with existing HELOCs can quickly access large sums of cash whereas people without access to such products may have to face an agonizing wait to obtain funds. Other people use HELOCs to finance short-term projects such as house-flips. Due to the variable interest rates and the danger of rising payments, few people view HELOCs as alternatives to long-term conventional mortgages or fixed rate home loans.

                   

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About the Author

Ciaran John began writing in 1994 with contributions to "The Hourly Press" and "The Sawbridgeworth Observer." He holds a Florida Life, Health and Variable Annuity license as well as series 6 and 63 securities licenses. He has a Bachelor of Arts in theology from Kings College in London.

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