Early HELOC repayments: 3 questions homeowners should ask

The Federal Reserve held steady with no changes to the federal funds rate after its March meeting. Inflation and economic uncertainty led the Fed to maintain what's often used as a benchmark interest rate that can affect the cost of borrowing. As these challenges continue, homeowners can tap their home equity as a cost-effective alternative. Home equity lines of credit (HELOCs), in particular, offer flexible financing at lower rates. 

While average credit card interest rates currently top 21% and average personal loan rates are around 12%, according to Federal Reserve data, HELOC interest rates have hit a two-year low and are now just below 8%. And, with potential rate cuts down the line, HELOC rates could drop further. And, home equity lines of credit offer flexibility, allowing you to draw from a credit limit, repay and access available funds again, similar to a credit card. That can be a big perk for borrowers.

There are a few unique things to know about the repayment process, though. HELOCs have draw periods where you can access the funds and repayment periods to pay off what you borrow. While you're in a HELOC draw period, you may only be on the hook for interest payments on the amount you use, but during the repayment period, your monthly payments will jump significantly to pay off both the principal and interest. So, if you're interested in paying it a HELOC before the draw period ends, there are some important questions you should ask first. 

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Early HELOC repayments: 3 questions homeowners should ask

Before borrowing from your home equity or paying off your HELOC early, consider these questions.

Can you make HELOC repayments immediately?

Whether you're shopping around for a HELOC or already have one, it's key to understand the terms of your loan agreement. One of the main things to find out is if you can make HELOC repayments immediately and pay off your balance early. You may be able to pay off your HELOC early before the draw period ends, but check with your lender. 

"Check if there are any prepayment penalties or hidden costs. So most HELOCs are fairly flexible, but I think it's worth checking and not being surprised," says Nadia Evangelou, senior economist and director of real estate research at the National Association of Realtors (NAR).

Not all HELOC lenders charge prepayment penalties, but some do. As an example of what that could look like, U.S. Bank charges borrowers 1% of the credit line up to a maximum of $500 if you repay and close your balance within 30 months. If you received an introductory offer or special pricing, read the fine print. 

"A lot of home equity lines of credit or companies market their home equity line of credit with no closing costs at some kind of initial rate that's lower than the market," says Jason Lerner, branch manager at First Home Mortgage. "And a lot of times, if there's some of those specials, they often require that you keep the loan open for a certain amount of months." 

Lerner notes that all HELOC lenders are different and have their own policies.

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Why should you make HELOC repayments immediately?

A HELOC typically offers borrowers a generous 10-year draw period. The repayment period could last from 10 to 20 years, depending on the terms and your lender. In other words, the HELOC draw and repayment periods together can be lengthy. 

That's quite some time to carry on monthly payments. Additionally, some HELOCs may require a balloon payment, which means you pay what you owe in full. Even if that's not the case, your monthly payments will notably increase when transitioning from the draw period to the repayment period. Making early HELOC repayments can be more financially sustainable. 

"Often, it's actually better served for long-term financial goals to start paying it back immediately," says Lerner.

Making early HELOC repayments can:

• Speed up repayment
• Lower interest charges
• Avoid major jumps in monthly payments
• Get out of debt faster 

After you pay off your HELOC, you effectively increase your cash flow by getting rid of those monthly payments. 

Why shouldn't you make HELOC repayments immediately?

Paying off a HELOC early can be a financially savvy strategy. But it might not be the right move for everyone. Given these uncertain times, if your job or industry is under the threat of looming layoffs, you likely don't want to repay your balance early. Having more cash on hand, in this case, can be a much-needed safety net. 

Lerner notes that consumers who are "using those funds for something positive and getting a better return on investment than they would by doing something else" may not want to pay off a HELOC early. 

If you value the flexibility of a HELOC and want to maintain that access by keeping the line open, paying it off early doesn't make sense. 

The bottom line 

HELOC users can benefit from the flexibility the draw period provides. However, the HELOC repayment period could be an unpleasant surprise if you're not prepared. That's why it can be a smart idea to make HELOC repayments early.

If you're interested in this financing tool, check with multiple home equity line of credit lenders to review rates and prepayment policies. Also, remember that HELOC interest rates are variable and fluctuate. If you prefer a fixed rate, you can look into home equity loans. 

Before submitting a HELOC application, look at eligibility requirements and pay close attention to potential fees. 

"I think home equity lines of credit are great for short-term needs. I think for a very long term, it just requires discipline to start making extra payments and being aware that the prescribed payment only is covering the interest," says Lerner.