How is HELOC Interest Calculated? How Does HELOC Interest Compare to Mortgage Interest?

What is the key to saving money when accessing your home equity? Two words: Interest calculation.

When borrowing against your home, two options are a home equity line of credit (HELOC) or refinancing with a traditional mortgage.

Both let you access your home’s equity, but they differ significantly in interest calculation.

So, how is HELOC interest calculated? In this article, we’ll break down how HELOC and mortgage interest work, how payments change over time, and what factors influence rates.

HELOC interest calculation

A HELOC is a revolving line of credit, meaning you can borrow up to a set limit as needed.

Unlike a mortgage, which gives borrowers a one-time lump sum deposit, a HELOC functions more like a credit card—you only pay interest on what you borrow.

Variable interest rate

Most HELOCs have variable interest rates, meaning they fluctuate over time.

The interest rate is typically tied to a financial index, such as the Prime Rate, plus a margin set by the lender.

For example, if the Prime Rate is 6% and your lender adds a 1% margin, your HELOC interest rate would be 7%.

If the Prime Rate rises to 7%, your rate jumps to 8%, increasing your interest costs.

Interest-only payments during the draw period

A HELOC has two phases.

Draw period (3, 5 or 10 years)

During this phase, you can borrow as needed. Most HELOCs require interest-only payments, keeping monthly costs low.

However, since you’re not paying the principal, your balance remains unchanged unless you make extra payments.

Repayment period (10 to 20 years)

Once the draw period ends, borrowing stops, and you must start repaying both principal and interest. This shift often leads to significantly higher payments.

How HELOC interest changes over time

Since most HELOCs have variable rates, interest costs can rise or fall based on market conditions.

If rates increase, your monthly payments will go up. Your payments will increase once the repayment phase begins since you also pay the principal.

Factors that influence HELOC interest rates

Several factors affect the interest rate you’ll receive:

• Prime Rate fluctuations: Since HELOCs are tied to the Prime Rate, any changes to this benchmark directly impact your rate.
• Credit score: HELOCs, like most loans, are tied to credit scores—this means borrowers with higher credit scores can typically expect lower margins on their HELOC interest rates than borrowers with lower scores.
• Loan-to-value (LTV) ratio: Generally, more equity in your home equals a lower LTV ratio, which can equal a more favorable loan rate for you.
• Lender terms: Some lenders offer low introductory rates that adjust after a set period.

Mortgage interest calculation

A mortgage provides a lump sum you repay over a fixed term, typically 15 or 30 years.

Unlike a HELOC, mortgage payments remain stable due to structured interest calculations.

Fixed vs. adjustable mortgage rates

Mortgages come in two main types:

1. Fixed-rate mortgages: The interest rate stays the same for the life of the loan, ensuring predictable payments.
2. Adjustable-rate mortgages (ARMs): These start with a fixed rate for a set period (e.g., five years) before adjusting periodically based on market rates.

Amortization and monthly payments

Mortgages follow an amortization schedule, where each monthly payment covers interest and principal.

In the early years, most of your payment goes toward interest. Over time, as the loan balance decreases, a larger portion will be applied to the principal.

For example, in a 30-year mortgage, up to 80% of your initial payments may go toward interest. By the final years, the bulk of each payment reduces the loan balance.

Comparing HELOC vs. mortgage interest calculation

Key differences in interest calculations over time

A HELOC offers unique interest-related advantages compared to a traditional mortgage, particularly in the early stages of borrowing.

While mortgages generally have lower interest rates due to long-term stability, HELOCs provide greater payment management flexibility.

Draw period advantages

One of the biggest benefits of a HELOC is the low-cost draw period.

During this phase, borrowers make interest-only payments, keeping monthly costs significantly lower than a mortgage, where payments always include both principal and interest.

This structure allows homeowners to access funds when needed without an immediate repayment burden.

No refinancing needed with HELOCs

Another advantage is that HELOCs don’t require refinancing.

If interest rates drop, you can pay off and reborrow at a lower rate, unlike fixed-rate mortgages which require refinancing to take advantage of better terms.

Additionally, while HELOCs typically start with slightly higher variable rates, they can still be cheaper in the short term, especially if you only need funds for a few years.

Unlike adjustable-rate mortgages (ARMs), which reset periodically, HELOCs allow for strategic repayment before rates rise.

If you’re seeking flexibility, lower initial payments, and access to revolving credit, a HELOC can be a more cost-effective alternative to a mortgage.

Choosing between a HELOC and a mortgage

The right choice for you and your family depends on your specific financial situation:

• Need flexibility? A HELOC lets you borrow as needed, making it useful for ongoing expenses like home renovations.
• Prefer predictable payments? A mortgage provides stable, structured payments that make budgeting easier.
• Are you considering interest rates? If mortgage rates are low, refinancing may be a better option than using a HELOC.

Access your home’s equity with HomeEQ—flexible financing on your terms

A HELOC lets you borrow as needed, giving you the financial freedom to manage home improvements, consolidate debt, or cover unexpected expenses.

HomeEQ makes the process simple with a fully digital application, competitive rates, and quick access to funds.

Start borrowing smarter—find your rate with HomeEQ today.