A home equity loan can be a powerful tool when you need a large sum of cash. Whether you want to improve your home, pay off high-interest debt, or fund your child’s education, your equity can allow you to borrow money at a much lower rate than consumer credit cards.
Many people opt for a longer repayment term for a home equity loan to keep monthly payment amounts reasonable. But what if you find that your monthly cash flow has increased? Can you pay it off early? As with many things, the answer is in the fine print.
- Home equity loans are secured using the equity built in your primary residence.
- Home equity loans have a standardized monthly payment and term.
- Few home equity loans have an early payoff penalty, but read the fine print to make sure.
What Is a Home Equity Loan?
A home equity loan is a loan that is secured by the equity built in your primary residence. As you make mortgage payments, you build equity, whittling down the balance on the amount that you owe.
Equity is determined by subtracting the difference on your outstanding mortgage from the current market value of your home. You could build equity quickly if you bought your home when the market was much lower. That equity is then used to determine how much money a lender may let you borrow using your house as collateral.
Home equity loans are sometimes called second mortgages since they operate in a very similar fashion. Payments, interest rates, and terms are fixed for a standard amount of time, typically five to 30 years. And just like a primary mortgage, home equity loans charge interest. The longer the repayment term, the more interest that you pay back over time.
When you’re ready to make your final payment on your home equity loan, call your lender. Only they can give you the correct final payment amount based on how much interest has accrued in that payment cycle.
Can You Pay Your Home Equity Loan Early?
Since a lender earns its profit on the interest charged on any loan, it’s easy to understand why they would want to ensure that the full term was honored. However, most home equity loans don’t incur what is known as early payoff penalties. If they do have an early payoff penalty, it must be stated in the contract for the loan.
A borrower must read the loan contract’s fine print to ensure that no hidden penalty charges or fees are included. If legal language is difficult for you, ask your lender if there are early payoff penalties. As long as there are no explicit mentions of penalties for early payoff, you are free to pay extra on your loan until it is paid off.
In the odd case of an early payment penalty, it still may be worth paying off your home equity loan early. Depending on how many years you can shave off your contract, it may be worth paying a one-time penalty to save thousands in accrued interest.
Why Pay Off Your Home Equity Loan Early?
Now that you’ve learned that you can pay off your home equity loan early, you may want to weigh the pros and cons. Many borrowers choose a longer term for their loan so that they have more breathing room in their monthly budget with a lower monthly payment. But if they find that their income increases, paying more toward the principal of their home equity loan can save significant interest payments.
Before you start paying extra on your loan, run the numbers on how much you’ll save by paying it off early. If you borrowed at a low interest rate, it may be worth paying on your current payment plan and investing the money you would have used to pay off the loan faster. If your goal is to eliminate monthly payments, paying the loan off early may be more attractive than what you would earn in the market.
How Do I Pay Off My Home Equity Loan Early?
There are three ways to pay off a home equity loan early:
- Lump sum: If you’ve saved the remainder of your loan amount in a separate account, you can pay it off in one payment. You’ll have to call your lender to find your final payoff amount.
- Additional principal payments: You can add a certain amount to every payment to reduce the amount of principal that is earning interest.
- Sporadic payments: When you have extra cash, you can apply it to your loan. This is a great way to use bonuses or tax refunds.
Choose the way that makes the most sense for your monthly budget and long-term goals.
What is the minimum amount that I can borrow in a home equity loan?
Unlike a home equity line of credit (HELOC), which is a revolving credit line, a home equity loan is a set sum with standardized repayment plans. Each lender will have its own minimum loan amount, but $10,000 is a fairly standard amount.
Can I borrow the full amount of my equity?
No. Lenders will only loan a portion of your equity, even if you’ve paid off your home. Most lenders will only allow you to borrow 80% of the equity in your home.
What happens if I default on my home equity loan?
Defaulting on your loan can result in losing your house. Since you are using your home as collateral on the loan, a lender places a lien on your home. If the loan is not repaid, they can foreclose on the house to recoup their investment. In the case of a home equity loan, the primary mortgage will be paid first and then the home equity loan.
The Bottom Line
Paying off your home equity loan early is a great way to save a significant amount of interest over the life of your loan. Early payoff penalties are rare, but they do exist. Double-check your loan contract and ask directly if there is a penalty. You may feel better about signing a longer contract with lower payments if there is no penalty for an early payoff.