Penalty for Early Termination on a Home Equity Line of Credit

Significance

Home equity lines of credit ordinarily charge the borrower an annual membership fee. Some also charge transaction fees for borrowing against it, and opening fees for starting up the account. If the balance of the line of credit is paid off, no interest fees will need to be paid, however. Early termination fees may be worth paying if it saves the borrower money on the annual membership charges or any other associated membership fees.

Function

A typical home equity line of credit will be taken out for a set period of time, such as 10 years. Some, typically more expensive, lines of credit can be taken out for indefinite periods of time. Most home equity lines of credit, however, are more complex than that--they have a limited "draw" period that allows the borrower to take out money against the equity on his home until it expires. Once the draw period is over, the line of credit closes, and then the borrower needs to pay back the balance with interest.

Considerations

For households struggling with a debt, sometimes cutting off all access to lines of credit helps to impose some financial discipline. The often hefty termination fees and the relatively low interest charged on home equity lines of credit, however, makes them less less attractive targets for zealous household debt-trimmers. Used responsibly, home equity lines of credit can be used to pay off higher interest debt quickly to save substantial amounts of money on interest payments.

Expert Insight

Banks are not required by law to disclose the early termination fee attached to their home equity lines of credit. People looking to open such a line of credit should ask the lending agent about any applicable early termination fees specifically before opening an account. Homeowners that plan to sell their home are almost always required to immediately pay off their line of credit in full and close the account--incurring the early termination fee in the process.

Effects

Banks apply the early termination fee to retain loan customers and to reduce their own risk. Lines of credit place a good deal of responsibility in the hands of the borrower. A sudden closure in the account can mean losses for the bank that it probably was not expecting. The termination fee increases the predictability of the business, although it is unfriendly to consumers and reduces borrower flexibility. Beware of deceptive marketing that does not mention the termination fee or buries it in fine print.