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Published August 01, 2022 Fact checked by Fact checked by Amanda JacksonAmanda Jackson has expertise in personal finance, investing, and social services. She is a library professional, transcriptionist, editor, and fact-checker.
A home equity line of credit (HELOC) is a way of accessing the equity that you’ve built up in your home. With a HELOC, you use your home as collateral for a line of credit. The amount of credit available to you depends on factors like the amount of equity in your home, your credit score, and your debt-to-income (DTI) ratio.
Because these loan types are secured by an asset (your home), they tend to have better interest rates than credit cards or personal loans, especially if you have a low credit score. The downside is that if you fail to pay back the borrowed money within the specified time frame, you could lose your home to foreclosure.
HELOCs can offer several advantages, but they have costs to consider. For example, if you want to pay the balance off early, you could face penalties. Though these charges may not always be labeled as a prepayment penalty, as they are with home equity loans, they function in the same way.
To understand why some HELOC loans have closing costs, we must look back at their history. When HELOC loans were first conceived in the 1980s, they worked as revolving loans, using the borrower’s home equity to secure the loan.
Some states had laws that made HELOCs illegal as revolving loans: if a borrower had paid off their loan, then the lender had the obligation to release the lien on their house. Also, mortgages that didn’t come with an explicit term were prohibited in some states. To be legal nationwide, HELOC agreements had to come with a specific payoff date. As a result, the consensus was that HELOCs could have prepayment penalties.
Lenders set prepayment penalties as a way to protect their funds. A lender makes money on the loan through interest that is paid by the borrower each month throughout the loan term. If a HELOC loan is closed early, the lender won’t earn the expected profit generated by the interest. In other words, prepayment penalties are what lenders use to compensate for the lost interest.
Some people turn to a HELOC to consolidate high-interest debt. However, if you are having trouble paying your bills, consider the downsides. If you cannot make your HELOC payments, you could put your home at risk of foreclosure.
Some HELOC loans have some kind of prepayment penalty or a fee associated with paying off your HELOC early.
HELOCs are structured as multiyear contracts, and you can be charged a flat fee when you close your account, regardless of your account balance. This fee will apply if you open a HELOC, then pay it down and close it before the period specified in your loan terms.
In other cases, the lender’s terms will allow them to recapture closing-cost fees from HELOC borrowers who close their credit line within a specified period, often within two to three years, after the loan begins. Lenders might document the waived closing costs or charge a flat fee that approximates the original costs.
HELOC loans can vary significantly in this regard. Be on guard for unscrupulous lenders that will charge high fees as you read the fine print. The federal Truth in Lending Act (TILA) requires lenders to disclose all the terms and costs of their home equity plans, including prepayment penalties.
You should also seek expert help if you are unsure if a loan is right for you. You can check whether a housing counselor is approved by the U.S. Department of Housing and Urban Development (HUD) or find a HUD-approved housing counselor by visiting HUD’s website or calling HUD’s housing counselor referral line at (800) 569-4287.
Most HELOC loan agreements won’t mention prepayment penalties. However, some HELOC loans will charge fees that are essentially an early repayment penalty. Make sure that you read the fine print, and consider consulting a professional advisor.
You can repay a home equity line of credit (HELOC) early, but you might have to pay penalties. You should check your loan agreement to see if early repayment penalties apply to you, and whether they will make paying back your loan early more expensive.
It depends on the terms of your loan. Make sure to read the fine print before taking out a HELOC to avoid any surprises. Talk to a U.S. Department of Housing and Urban Development (HUD)-approved housing counselor if you are unsure whether this type of loan is right for you.
Many HELOC loans have no early repayment penalties. However, some loans may have these kinds of fees. It’s important to read the fine print before agreeing to a HELOC, and to seek expert advice if you are unsure about the terms that you are being offered.