Interest-Only HELOC or Principal Plus Interest: Does It Matter When Your Paycheck Runs Through It?

A HELOC is a home equity line of credit, which means a revolving credit line secured by your house. Banks offer two payment styles. With interest-only, your required payment covers just the interest. With principal plus interest, the required payment also pays down some of the balance. Which one you can get depends on what your bank requires and how long it lets you borrow and repay. I covered the choice in a quick tip on interest-only versus principal plus interest HELOCs.

The only real difference is the size of the minimum payment each month. That payment shows up on your credit report. It matters when a lender checks your debt-to-income ratio, which means your monthly debt payments compared with your monthly income. If you're applying for a home loan or a car loan soon, a bigger required payment on your credit report makes that ratio worse. With a zero balance, neither type shows a payment, so there's nothing to compare.

Now consider how I use a HELOC. In Dynamic Banking, I run my whole income through the line of credit each month, which I call paycheck parking. That lowers the balance each payday, so less interest builds up. My own HELOC has a minimum payment of 1% of the balance. On a $70,000 balance that's $700 for the month. But thousands of dollars flow in each month, so the bank's minimum is far below what I'm already paying. The required payment never drives my decisions.

That's why I say the choice is yours. If you're running your paycheck through the HELOC, you can ignore the minimum either way. If you expect to apply for a mortgage or car loan in the next year or so, interest-only is easier on your debt-to-income ratio, because the lender sees the smaller required payment.

The same thinking applies if you're using a HELOC to fund a policy. The money you put into premiums is borrowed, and the balance can grow over several years. The lender still sees only the minimum payment, so know which kind you have before you apply for anything else.

Some cautions come with either type. HELOC rates are usually variable, which means your cost can go up. Your home secures the line of credit. And a minimum payment you can ignore this month is still a payment due if your income stops. Read the loan terms for how long you can borrow and what happens when that period ends. Ask your bank for those dates in writing before you sign.

If your plan includes a mortgage application within the next year, ask your lender how they count a HELOC payment before you draw a dollar.