A Home Equity Line of Credit (HELOC) is a useful financial tool if you have a lot of equity in your home and need some cash flow. This line of credit allows you to use that equity as collateral and borrow as needed, similar to using a credit card. You have a 10 or 20 year term to pay back the funds in monthly installments.
But let’s say you want to pay off your HELOC balance early, which you can do, but be aware that lenders may impose HELOC early repayment penalties.
How a HELOC Works
A HELOC lets you tap into the equity in your home. When you open a HELOC, you gain access to a line of credit. The line of credit is usually available for a 10-year draw period, during which you make interest-only payments. After the draw period, you have 10 or 20 years to repay the amount you borrowed plus any accrued interest. HELOCs usually have adjustable interest rates, so your payments change as interest rates fluctuate.
What is a HELOC prepayment penalty?
When you enter the repayment period of a HELOC, you’ll have a specific period of time to pay off your outstanding balance, and if you make the minimum payments, you’ll be able to pay off the debt in full within that period.
However, you can also pay off your balance faster by making a lump sum or adding an additional amount to each payment. A HELOC early repayment penalty is a fee that a HELOC lender charges if you prepay your debt beyond the minimum payment. You may also be assessed a penalty if you pay off and close a line of credit within a certain period of time after opening it (while you’re still in the drawdown period).
Why do lenders charge a HELOC prepayment penalty?
Lenders make their profit primarily by charging interest on the products they offer, plus annual and maintenance fees. For contracted products like HELOCs, lenders calculate their profit based on the entire term, or interest over the entire life of the loan. If you pay off your HELOC early and exit, it reduces the lender’s revenue stream early. To make up for that loss, lenders charge fees.
Some lenders tempt borrowers with “no closing costs” HELOCs, but these often come with the condition that the lender can recoup closing costs through (wait for it) an early closing fee.
When do lenders charge prepayment penalties?
While the exact timing varies by lender, there is usually a specific point during the lifecycle of a HELOC at which lenders will charge an early repayment penalty.
- During the lottery period: A HELOC’s draw period is the period for which you can borrow from the line of credit, usually five to 10 years. If you close the HELOC during this period, especially within the first two years, the lender may charge you a mortgage prepayment penalty, says Chad Gammon, a financial planner at Arnold & Mort Wealth Management in Iowa City, Iowa. “This fee compensates the lender for the interest they didn’t earn because the line of credit closed sooner than expected,” Gammon says.
- During the repayment period: The repayment period is the period during which you can no longer borrow and must repay the outstanding loan balance. Repayment periods can last anywhere from 10 to 20 years. If you pay off your loan in full before the end of the period, you could incur an early repayment penalty on your HELOC. “Some lenders stipulate that if you pay off and finish your HELOC within a certain number of years from the start of the repayment period (usually within the first three to five years), you may be subject to an early repayment penalty,” Gammon says. “This period should be clearly written into your loan agreement.”
What is the typical prepayment penalty for a HELOC?
The exact amount of the prepayment penalty will vary depending on the lender. Generally, you can expect the fee to range from 2 percent to 5 percent of the loan. In some cases, the fee your lender charges may be based on how quickly you prepay your HELOC.
For example, if you close a HELOC before the three-year mark, you’ll pay a three percent penalty. You might also be hit with a five percent penalty if you close a HELOC before the five-year mark. Some lenders may choose to charge a flat fee for early closing, which usually amounts to a few hundred dollars. For example:
Bank of America charges a $450 fee if you close your account within 36 months of setting up a HELOC.
Rockland Trust Bank may assess a $500 early termination fee if you close or cancel a line of credit within 24 months of opening.
U.S. Bank may charge an early closing fee of 1 percent or up to $500 if the line of credit is closed and repaid within the first 30 months.
How to Avoid HELOC Prepayment Penalties
Not all lenders charge early repayment penalties on HELOCs; banks often do, so if you’re worried about incurring penalties, it might make sense to go with a non-bank lender if you can secure a competitive interest rate.
The federal Truth in Lending Act (TILA) requires lenders to disclose all costs, surcharges, and other charges associated with a HELOC, including prepayment penalties. So be sure to read and understand the terms of your credit line carefully before you commit. Keep in mind that these penalties may go by a variety of names, including “early closing” or “early termination” fees. Don’t be afraid to ask questions about any terms you don’t understand.
If your line of credit does in fact have a prepayment penalty, you can choose to incur that cost when you repay the loan or wait until the penalty period has passed before making the payment.
“If your lender charges a penalty for closing a HELOC during the draw period, one strategy is to pay off the balance to zero and keep the line of credit open until the draw period ends,” Gammon explains. Once the draw period ends, most lenders will close a zero-balance HELOC without a penalty.
However, there may be other fees: “HELOCs may charge annual fees or dormancy fees, so be sure to keep an eye on those fees and weigh the cost of maintaining the line of credit against the penalty for closing early,” Gammon says.
Can I negotiate prepayment penalty fees with my lender?
Yes, just like with any loan, you have the option to negotiate with your lender about your mortgage prepayment penalty. Of course, there’s no guarantee that the lender will agree to waive or modify the penalty, but it’s worth the effort.
“You need to think through your approach and have a strong case for why the penalty should be eliminated or reduced,” says Christina McCollum, market leader at Kennewick, Washington-based Churchill Mortgage.
“It’s in the borrower’s best interest to make a strong case,” says McCallum. “For example, is the borrower experiencing hardship? How much of the drawdown period is left? These factors will vary from case to case but can make a difference.”
If you have a long-standing relationship with your lender, be sure to highlight that fact during negotiations as well, and don’t be afraid to speak to a more senior representative if the account representative you’re dealing with doesn’t seem to be doing anything for you.
What are the benefits of paying off a HELOC early?
Although there can be penalties for paying off or closing a HELOC early, in some cases it may be wise to eliminate the debt up front. Here are some benefits:
- Pay less interest: A HELOC often has a repayment term of 10 to 20 years, during which time you accrue interest on the loan. By paying off your HELOC many years in advance, you can avoid paying a lot of interest. In many cases, the interest you avoid is much greater than the penalty you would incur for terminating the loan early.
- Streamline your monthly payments: Managing multiple debts and making monthly payments can be a challenge, so eliminating HELOC debt can help streamline your bookkeeping.
- Lower your debt-to-income ratio: Having too much debt relative to your income limits the amount of cash you have available and lowers your credit score. Paying off your HELOC early can create more room in your monthly budget and improve your debt-to-income ratio, which is important if you plan on applying for credit in the future.
- Increased financial security: Paying off a HELOC early can be a psychological relief, it can also help your credit score by reducing the amount of credit you’re using, and of course, paying off your HELOC eliminates any potential liens against your home.
The Final Word on HELOC Prepayment Penalties
Some HELOC lenders don’t charge a fee for prepayments, but some do, so be sure to read and understand the fine print before you commit to a line of credit. Information about prepayment penalties is usually hidden in there. By law, lenders must clearly state whether they impose a penalty, but remember that penalties may also go by more innocuous-sounding names, like “early termination fees” (though “penalty” has a rather negative connotation).
Whatever you call it, it’s an extra expense.
Considering that you could save thousands of dollars in interest by paying up front, a penalty of a few hundred dollars is more of an annoyance than a drawback, but it’s still good to be aware of it and discuss it so you can avoid it if possible.
