How to Pay Off Home Equity Loans

Home equity loans, also referred to as second mortgages, allow homeowners to borrow large sums of money based on the value of their homes. They offer more attractive interest rates than credit cards or other loans, and interest is tax deductible. Closing costs are lower with home equity loans than first mortgages, but their fixed rates are usually slightly higher. Review the monthly payment terms outlined in a home equity loan contract carefully, and don’t agree to repayment terms that you can’t afford. Because your home is used a collateral, you risk losing it if you fail to make payments. There are several ways you can pay off a home equity loan. Paying it off faster can help you spend less on interest.

Pay Extra on the Principal

Pay more than the minimum payment each month. Be sure to specify on your check or the portion of the statement you return with your payment that the extra money is to be applied directly to the principal. If you pay with an extra check, indicate that the extra money is to go toward the principal balance. Verify with your lender that every extra dollar has been applied correctly to your account. This will save you money on interest and allow you to pay off your loan much sooner.

Refinance to Reduce Interest

Refinance to a shorter term, but only if you can get an interest rate at least one point lower than your current rate. Lenders usually offer lower rates on shorter-term loans, which allows you to pay off the loan early. As a general rule of thumb, it only pays to refinance if you do it before you reach the halfway point in your mortgage term. This is when you will finally be paying more in principal than interest. Keep in mind, too, most of the time lenders charge fees to refinance, and this adds to the cost of the loan.

Selling the House

Pay off your home equity loan when you sell your house. This is a requirement. Therefore, make sure that you can ask a high enough price for your home to cover the loan and pay off your first mortgage.

Choose the Right Loan

Choose a home equity loan that offers you regular installment loan terms. That way you will be paying a minimum amount on both the principal and the interest each month. Talk to your lender about credit insurance. This may include life insurance, disability insurance and unemployment insurance. Credit life insurance is set up to pay off your home equity loan if you die. Discuss other options with your regular insurance agent, as a traditional life insurance policy may be cheaper yet provide the same benefits.

Avoid Balloon Loans

Examine your loan agreement, as some home equity loans are not amortized. Taking out a loan with a balloon payment means that you will have an outstanding balance that is due at the end of the loan term. This could be the full amount of the principal, as your monthly payments would only be covering the interest. You would still owe the entire amount you borrowed in the end. Unless you will have the cash before the loan term expires, you may need to take out another loan to pay off the balance. Review the terms of your loan contract to see if you will be penalized for paying off your loan early.

Watch for Prepayment Fees

Many lenders charge a prepayment fee if you pay your loan in full within a specified number of months of the date when you close the loan. Some lenders charge a flat prepayment fee. Others will waive the prepayment penalty if you refinance your loan with that lender. In most cases, the fee will be a percentage of the original loan amount. Generally, fees do not exceed 1 percent of the original loan amount, although a prepayment penalty can be as high as 10 percent. Don't use home equity to pay off short-term debts or to purchase something that won’t last through the term of the loan.

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