HELOC Loan Prepayment Penalties

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.

Understanding HELOC Loans

To understand why some HELOC loans have closing costs, consider the history of these loans. When they were first conceived in the 1980s, they worked in much the same way as a credit card, as revolving loans. They used a borrower’s home equity to secure the loan.

At one time, some states had laws that made HELOCs illegal as revolving loans. According to some state laws, if a borrower had paid off their loan, then the lender had to release the lien on their house. Other state laws prohibited mortgages that didn’t have an explicit term. To be legal nationwide, HELOC agreements had to be written with a payoff date. The end result was that HELOCs could have prepayment penalties.

Lenders set prepayment penalties because they want to protect their profits. A lender makes money on the loan through interest that is paid by the borrower each month along with payment toward the principal. If you close a HELOC loan early, the lender won’t earn its expected interest profit. So, lenders try to recoup some of this lost interest with a prepayment penalty.

HELOC Prepayment Penalties

Many 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.

The Bottom Line

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.