You have a home equity line of credit (HELOC) and want to pay it off early. Is this an option, or will you be penalized for doing so? In short, you can pay off the principal balance during the draw period, but you could be subject to early repayment fees.
Read on to learn more about the potential outcomes of paying off your HELOC early and alternatives that could make financial sense.
Understanding a HELOC: Basics and Definitions
Before diving into what to expect when paying off a HELOC early, here’s a look at the basics of this home equity product.
What is a HELOC?
A HELOC is a revolving line of credit that lets you tap into your home equity. The amount you can borrow is based on how much equity you’ve built up – typically capped at 85%. This is computed by multiplying your home’s appraised value by the percentage equity you have and deducting the mortgage you owe. For example, if you have a home that is appraised at $1 million and you have a $500,000 mortgage, you may qualify to borrow up to $350,000.
Upon approval, you get a pool of cash to pull from up to the limit. You’ll typically make interest-only payments during the draw period, which usually spans five to 10 years. And, like a credit card, you’re free to pull from the line as it replenishes as often as needed.
When the draw period ends, the repayment period starts. You can expect the monthly payments to be higher since they’ll include both principal and interest. The rate on HELOCs is generally variable, so the monthly amount you pay will fluctuate with market conditions.
Keep in mind that a HELOC acts as a second mortgage and uses your property as security. So, defaulting on the loan could subject your home to foreclosure.
Is It Possible to Pay Off a HELOC During the Draw Period?
Yes, you can pay off a HELOC before the draw period ends. Although most lenders only require interest payments during this window, you may have the option to pay towards the principal balance to eliminate the outstanding balance sooner.
Draw Period vs. Repayment: When Should You Pay Off Your HELOC?
If you choose to pay off your HELOC during the draw period, you could save a sizable amount in interest. That said, you could also incur early repayment penalties if you go with this option. So, it’s worth weighing the benefits of an early payoff against the cost of doing so (if applicable) to make the best decision.
What Happens If You Pay a HELOC Off Early?
A few things happen when you decide to pay off your HELOC during the draw period. For starters, you’ll enjoy reduced borrowing costs and monthly payments. Your repayment period will also be shorter. More on the specifics of these perks will be provided shortly.
The Benefits of Paying Off a HELOC Early
Here’s a closer look at the benefits of paying a HELOC early:
- Reduced interest costs: Paying off your HELOC early gives the lender less time to collect from you, which results in lower borrowing costs.
- Lower monthly payments: If you’ve already paid down a substantial portion of the principal, your monthly payments will be much lower when the draw period ends.
- Shorter repayment period: You can shorten the loan term by paying off your HELOC early to create more wiggle room in your budget.
- Preserve home equity: Borrowing against a HELOC eats into your home equity, but you can restore it by repaying your HELOC sooner rather than later.
- Peace of mind: Paying off your HELOC early can also provide you with peace of mind, as you’ll have one less debt payment to make each month.
Financial Implications of Paying Off a HELOC Early
Below are some additional financial considerations to be aware of if you pay your HELOC off early.
Interest Savings and Financial Benefits
The interest you pay on a HELOC is based on the principal balance. So, if you’re able to lower it during the draw period by paying above the minimum each month and towards the principal, your borrowing costs will be lower, and you’ll pay off your HELOC sooner.
Potential Fees and Penalties to Be Aware Of
Again, paying off your HELOC can create more room in your monthly spending plan. But there’s also a potential downside. If your lender assessed prepayment penalties, the cost of paying ahead of schedule could outweigh the financial benefits. So, it’s vital to run the numbers if your lender assesses fees for early repayment to decide if it’s a smart financial move.
Impact on Your Credit Score
Credit utilization accounts for 30% of your credit score. It’s measured by the percentage of your credit line in use, and your credit score benefits the most when this percentage is 30% or lower. So, paying off a HELOC early could help improve this rate, potentially giving your credit score a boost. Furthermore, eliminating the balance from a line of credit on your credit report can help lenders view you in a positive light.
But be careful not to close the HELOC once you pay it off. Credit age is another significant component of the credit-scoring equation – accounting for 15% – and closing the account prematurely could hurt your credit score. Instead, consider keeping it open after you repay the balance if there are no maintenance fees, so your credit health will still benefit even if you’re no longer using it.
How to Pay Off a HELOC During the Draw Period
It’s best to have a payoff strategy if you plan to ax your HELOC debt during the draw period. Here are some tips to help you come up with a practical plan.
Calculating Your Outstanding Balance
Start off by calculating the total amount you owe on the HELOC, including the principal balance and any interest you’ve accumulated so far. You should be able to find this information on your statement, or you can contact the lender directly to confirm.
Strategies for Paying Off Your HELOC
Once you have the balance handy, the next step is to decide how you’ll tackle the HELOC debt.
- Making Lump-Sum Payments: If you have the funds available, you can choose to pay off the total balance at once.
- Increasing Monthly Payments: You also have the option to increase your monthly payments to reach the finish line faster. Be sure to specify that the overage should be applied to the principal balance each time you make a payment.
- Applying Extra Income or Windfalls: If you receive a financial windfall, like a monetary gift, inheritance or tax refund, you can use it to accelerate the repayment process. You can also pick up overtime, a part-time job or a side hustle and allocate the funds earned to pay down your HELOC faster.
Contacting Your Lender for Payoff Instructions
When you’re ready to pay off your HELOC, be sure to contact the lender for specific instructions. Each lender has its own procedures, and you want to follow them to avoid issues later on down the line.
Before paying the balance in full, request a detailed breakdown of your payoff balance. It should include any interest you’ll be charged until you make the final payment.
Alternatives to Paying Off a HELOC During the Draw Period
If you want to manage your HELOC more effectively but aren’t sold on the idea of paying it off early, consider these alternatives.
Refinancing Your HELOC
You can refinance your HELOC to secure more favorable loan terms or a better rate. If you have good or excellent credit, you may qualify for a better deal on a refinance to lower borrowing costs. Or you can potentially extend your loan term to make your monthly payments work better for your budget.
Converting to a Fixed-Rate Home Equity Loan
There’s also the option to switch to a fixed-rate home equity loan. Doing so gives you a fixed interest rate and a set monthly payment for the duration of the loan term.
Using Savings or Investments
If you have a substantial amount saved or income from investments, you can also use those funds to pay off our HELOC early. Even if it’s not in a lump sum, you can pay extra each month to significantly reduce the principal balance, which in turn reduces interest costs.
Conclusion: Should You Pay Off Your HELOC Early?
By paying off your HELOC early, you can reduce your debt load and potentially save a bundle in interest. Be sure to check with your lender to confirm there are no prepayment penalties before moving forward. Otherwise, the costs of paying off your HELOC in advance could end up outweighing the benefits.
FAQs About Paying Off a HELOC During the Draw Period
Yes, you can make extra payments on your HELOC during the draw and repayment periods to lower the principal balance. Doing so also reduces the amount you pay in interest, as borrowing costs are based on the principal balance.
The interest you pay on a HELOC could be tax-deductible if the funds are used to make qualifying home improvements. Consult with a tax professional to learn more.
No. The revolving line of credit stays open until the draw period ends.
