How to pay off your home equity line of credit early

Borrowers often wonder if they can pay off their home equity line of credit (HELOC) early. The short answer? A resounding yes, because doing so has many benefits.

But how does paying back a HELOC work? Paying off debt sooner means you'll owe less in interest over the life of the loan, which saves you money. The simple way to do this is to decrease your charges or draw on the HELOC while increasing the amount of your monthly payments. Lowering the outstanding balance also decreases your loan-to-debt ratio, which is attractive to lenders and can help you meet your personal financial goals.

To select the right approach, you'll first need to understand how paying off a HELOC early works. Of course, you'll want to check with your lender to ensure you won't incur a prepayment penalty. And like anything else, you'll want to do your due diligence and run the numbers to make sure the extra payments fit into your budget. Then you can set up a solid repayment plan.

How a HELOC works

Since you've already got a HELOC, chances are you know the ins and outs of your loan terms. If you don't or need a refresher, remember that a HELOC features two distinct periods: the draw period and the repayment period.

HELOC Draw period

During the draw period, you can use the funds available up to the line amount, just like the credit limit on your credit card. Typically, you're only required to make interest payments during the draw period, which tends to be 10 to 15 years. You can also make payments toward the principal during the draw period. When you pay off part of the principal, those funds go back to your line amount.

HELOC Repayment period

When the draw period ends, which is usually after 10 to 15 years, you enter the repayment period. During this time, no further draws may be taken on the line of credit even if you have not used all of the available credit. You will begin paying back the remaining principal on your HELOC, plus interest. It's important to understand that most HELOCs offer variable interest rates, but borrowers sometimes can negotiate with the lender for a fixed interest rate for the remainder of the repayment period.

How do I calculate payments on a HELOC?

When you enter the repayment period, your HELOC effectively converts to a traditional mortgage loan. The current balance is treated as the principal, and the interest rate is applied to calculate the necessary payments to amortize the balance down to zero by the end of the repayment period. For example, if you enter a five-year repayment period with a $10,000 balance and a 6% interest rate, you will pay $193.33 each month.

Be aware of prepayment penalties

Some lenders will charge prepayment penalties if you pay off your loan in the first three to five years of the repayment period. Whether you plan to pay off your HELOC when you sell your home, are refinancing or experience a financial windfall, a prepayment penalty could be an unexpected charge. Most prepayment penalties are about 2% of your loan balance, but the amount varies by lender. Make sure you check with your lender before you decide to pay off your loan early so you don't get caught off guard.

Typically, you won't face a prepayment penalty for contributing a small amount above the required monthly payments, but you should read your loan agreement carefully and discuss the terms with your lender before making a decision.

Alternate ways to pay off your HELOC

Rather than make monthly payments during the repayment period, you may want to consider paying off the entire balance. Evaluate your budget to see how much you can allot toward repayment of your HELOC. Are you concerned about how much interest you'll pay over the life of your loan? Go back to your budget to see if there's more room to make additional principal payments during the draw period. If you decide to make extra payments, be sure to alert your lender that the funds should be applied to the principal.

If you're looking for alternatives to help pay down your HELOC balance, here are a few options:

• Home equity loan. This fixed rate option may give you a lower rate than the current variable rate on your HELOC.
• Cash-out refinancing. If you've built up equity in your home, you may want to refinance your first mortgage and use some of the equity to pay down the HELOC. This will help you avoid having two loan payments to manage each month.
• A new HELOC. If your income or credit history has improved since you opened your HELOC, it may make sense to speak with a lender about additional line of credit options. Look over the information needed to submit an application to determine if you qualify for better rates or terms.

Have you paid off your HELOC?

Good for you! Now that you understand how to pay off a HELOC, you can take action to reduce your outstanding debt. This will help you maintain a healthy credit score and give you a psychological boost. But if you later decide to take on a new renovation project or you hear wedding bells in the air, opening another HELOC may help. Before you do, take a look at your options, because not all HELOCs are created equal.

Interested in applying for a HELOC? Citizens FastLine® can help you get started.