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A home equity line of credit (HELOC) can be a useful financial tool if you have sufficient equity in your home and need a stream of cash. Once you open a HELOC, you’ll have access to a line of credit, similar to a credit card. You might want to pay off whatever you borrow through the HELOC early — but be aware, your lender might charge a prepayment penalty to do so.
How HELOCs work
A HELOC allows you to tap your home’s equity to borrow funds as needed for expenses like ongoing home improvements or tuition. You can typically access the line of credit over a 10-year draw period, during which you’ll make interest-only payments. After the draw time, you’ll need to repay what you borrowed, along with any outstanding interest, usually over 10 years or 20 years.
HELOCs almost always have variable interest rates, so your payments will change as rates fluctuate. Unlike a credit card, your home is the collateral for a HELOC, so you risk foreclosure if you fall behind on payments.
Is there a prepayment penalty on a HELOC?
Although you’ll have a specific time frame to repay your HELOC, you might choose to pay it off sooner. While some HELOC lenders don’t charge a fee for prepayment, others do. This might also be referred to as an early closure or termination fee. If you repay and close the line of credit within a certain time after opening it, you’ll be charged this fee.
Before you commit to a HELOC, be sure you understand the fine print. Some lenders entice borrowers with a “no closing cost” HELOC, but these often come with the stipulation that the lender can recapture closing costs through an early closure fee.
How much is a HELOC prepayment penalty?
The cost of a HELOC prepayment penalty varies by lender, but is typically no more than a few hundred dollars. It might equal a percentage of the balance up to a certain amount.
Why do lenders charge HELOC prepayment penalties?
Lenders set prepayment penalties to protect their profits. Lenders make money by charging interest on the products they offer; your lender won’t be able to do that if you close your HELOC early.
How to avoid a HELOC prepayment penalty
If you’re concerned about a prepayment penalty, know there are several lenders that don’t charge one. Banks often levy this fee, so it might make sense to go with a non-bank lender, provided you can still get an attractive rate.
Carefully read and make sure you understand the terms of your HELOC. If your line of credit does in fact have a prepayment penalty, you might choose to absorb that cost at payoff, or wait until the penalty period has passed before prepaying.