Using a HELOC to pay off your mortgage could be a wise financial move, but here’s what you need to know.
As a homeowner, you might be able to use a home equity line of credit (HELOC) to pay off your mortgage. This unconventional approach is a way to complete mortgage payments early using only the equity you’ve built in your home. While it can benefit you, it also has some drawbacks to be aware of.
We spoke with Jose Garcia, president and CEO of Northwest Community Credit Union, to understand who may benefit from using a HELOC to pay off a mortgage and what they should know.
How Does Using a HELOC to Pay Off Your Mortgage Work?
A HELOC is a revolving line of credit from which homeowners can withdraw funds as needed, like a credit card, for all types of expenses, including paying off a mortgage. Your credit limit is determined by your home’s equity, which is its appraised value minus what is owed on the mortgage.
So, let’s say you own a $400,000 home and have $200,000 remaining on your mortgage – your home’s equity is $200,000. That doesn’t mean you can pay off your mortgage in one fell swoop, as lenders will only approve you for a percentage of that equity, typically up to 80 percent. In this example, that means you can be approved for up to $160,000, assuming you meet other HELOC requirements set by your lender.
The first phase of a HELOC is the draw period or the time you can withdraw money from the credit line for expenses like your mortgage. The HELOC draw period usually lasts up to 10 years, followed by the HELOC repayment period or the time you must repay the principal plus interest.
When Should You Pay Your Mortgage with a HELOC?
Paying your mortgage with a HELOC may not be for everyone, but it could be more advantageous for certain homeowners than others. Here are a few situations where Garcia would recommend using HELOC funds for your mortgage.
- If you have a high-interest mortgage: “If your current mortgage has a high interest rate, using a HELOC with a lower rate can reduce your overall interest payments,” Garcia says. Keep in mind, most HELOCs have a variable interest rate that might cause your monthly payments to fluctuate.
- When there’s an unexpected expense: “If you need to manage short-term financial needs or unexpected expenses, a HELOC can provide the necessary funds without refinancing your entire mortgage,” Garcia says.
- People planning home improvements: “If you plan to use the HELOC for home improvements, the interest may be tax-deductible, providing additional financial benefits,” Garcia says.
- Those looking to consolidate debt: “If you have high-interest debt, using a HELOC to consolidate and pay off that debt can save you money on interest and simplify your payments.”
When Should You Not Use a HELOC to Pay Off Your Mortgage?
If you receive interest rates that are higher than your current mortgage rates or close to them, you’ll likely spend more on the interest payments on the HELOC than if you maintain your current mortgage.
You’ll also want to evaluate where you are in your current mortgage term. The longer you’ve been paying your mortgage, the more your monthly payment will go toward your principal. That means you’ll pay off your loan faster than you would with a new HELOC.
Pros and Cons of Using a HELOC to Pay Off Your Mortgage
Here’s a look at some pros and cons for homeowners using a HELOC to pay off their mortgage.
Pros
- Lower interest rate: Depending on when you got your mortgage and today’s interest rates, you might be able to lower your payments using this strategy and pay less in long-term interest. The HELOC might require lower principal amounts, making monthly payments more affordable.
- Minimal closing fees: Some people opt for HELOCs instead of refinancing because the origination costs on the loan are smaller than refinances. It depends on the terms you find with your lender.
- Pay off your mortgage faster: You might be able to pay off your mortgage faster. With lower interest rates, your monthly payment will go down. But if you keep making the same payment you were, you’ll pay off the loan sooner, reducing the total cost.
- Potential tax benefits: “Interest paid on a HELOC may be tax-deductible if the funds are used for home improvements,” Garcia says. The Internal Revenue Service (IRS) states you can only write off interest paid on HELOCs if used for home renovations, though that rule will expire after the 2025 tax year. After that, you can deduct HELOC interest payments regardless of how you use the funds.
Cons
- HELOC terms are complex: You’ll encounter entirely new terms and processes. If you aren’t careful, you could put yourself in a worse situation with your loan.
- Misappropriation of funds: Some people spend the money on other things before paying off their mortgage, which makes the strategy less advantageous. “There is a risk of borrowing more than you can repay, which can lead to financial strain,” Garcia adds.
- Variable rates: Most HELOC loans use variable rates. That makes it hard to know that you’ll pay less in interest. And it can mess with your rates over the years while you work to pay it off. There are some fixed-rate HELOCs, but they’re not offered by many lenders.
- Equity reduction: “Using a HELOC reduces the equity in your home, which can be a disadvantage if property values decline,” Garcia says.
- Potential fees: “HELOCs can come with various fees, including annual fees, closing costs and early repayment penalties,” Garcia says.
How to Use a HELOC to Pay Off Your Mortgage
Tap into your home’s equity and use a HELOC to pay off your mortgage and gain better terms with a new loan. Here are the steps required.
Check HELOC Requirements
Even if the equity exists in your home, you must meet HELOC lender requirements to take out the loan. Some requirements include a good credit score (generally 680 or above), a good credit history, a debt-to-income ratio below 50% and an on-time bill payment history. Before getting too far into the process, ensure you meet these basic requirements.
Compare Lenders
Many lenders offer HELOCs. To get the best rates, compare multiple HELOC lenders to secure your preferred loan amount. Ideally, you want one that will waive the closing costs or reduce up-front fees to make the loan work for you.
Apply for a HELOC
Generally, a home equity line of credit is easier to apply for than a mortgage or a mortgage refinance because it is mostly based on how much equity you have in your home. The lender will look for you to have at least 20% equity in your home, though some lenders allow for 15%. You’ll also need to prove you have a steady income to repay the loan, so be ready with pay stubs or tax filings for the last few years.
Get a Home Appraisal
You'll need a home appraisal to prove that you have adequate equity in your home to take the line of credit. Some lenders allow for virtual home appraisals, which are less expensive. However, it depends on the estimates for your home and how much you owe on it.
Close on the Loan
Much like you did to get your mortgage when you bought or refinanced the home, you’ll go through a closing procedure. This is when you sign all the disclosures and information that clarify your interest rate and the repayment terms you’ve agreed to. This will also outline the draw, repayment periods and when you can access the funds. Read all these documents carefully before your closing date to avoid getting into a situation that doesn’t benefit you in the way you think it will.
Receive Your HELOC Funds
In most scenarios, you’ll receive the HELOC funds on the fourth business day after you close the loan. This generally involves a wire to your bank account.
Pay Off Your Mortgage
Use the funds in your bank account to pay off the mortgage balance. You’ll need to request a mortgage payoff estimate from your mortgage servicer and learn the steps you need to take to close your loan. It isn’t quite as simple as just paying the balance you see on your account. You must communicate with the lender to ensure you pay the correct amount.
Maintain Regular HELOC Payments
During the draw period, you’ll need to make payments on the interest on your home equity line of credit. Make sure you continue to do this. Ideally, you also should pay on the principal during this period to reduce the amount you pay in total interest.
Repay the HELOC Principal
Once you reach the HELOC repayment period, you’ll begin making principal and interest payments. Generally, you repay the principal over 10 or 20 years based on what you agreed to during your closing. Watch your variable rates to determine whether the line of credit is still a smart financial decision for you on an ongoing basis.
Helpful Tips
Here are a few important things to keep in mind when considering whether to use a HELOC to pay off your mortgage:
- Using a HELOC to pay a mortgage is only advantageous if the interest rates are lower than what you’re paying on the mortgage
- Make sure you can make the monthly payments
- Keep an eye on variable interest rates
- Spend the money wisely
Why You Should Trust Us
Benzinga has offered investment and mortgage advice to more than one million people. Our experts include financial professionals and homeowners, such as Anthony O’Reilly, the writer of this piece. Anthony is a former journalist who’s won awards for his coverage of the New York City economy. He’s navigated tricky real estate markets in New York, Northern Virginia and North Carolina.
For this story, we worked with Jose Garcia, president and CEO of the Illinois-based Northwest Community Credit Union. The credit union offers multiple financial services, including HELOC loans.
Frequently Asked Questions
Is it possible to pay off a mortgage with a HELOC?
Yes, you can pay off a mortgage with a HELOC if you have enough equity in your home.
Is it smart to use a HELOC to pay off a mortgage?
Sometimes, using a HELOC to pay off a mortgage is smart. You just need to ensure that the terms are more favorable than your current mortgage and that potentially variable rates won’t derail you.
What are the other alternatives to pay off a mortgage?
You have many options for paying off a mortgage, including refinancing, making biweekly payments, completing a reverse mortgage, taking a home-equity loan, doing a mortgage recast and selling the home.
Sources
- Jose Garcia, president and CEO of Northwest Community Credit Union
About Anthony O'Reilly
Anthony O’Reilly is an updates editor for Benzinga. He’s won numerous journalism awards for his coverage of the New York City economy and Long Island school district budgets.