When using the HELOC strategy to pay off a mortgage, it's important to compare HELOC rates with your current mortgage and note that HELOCs have variable rates, allowing for potential rate increases.
As a homeowner, you might be able to use a home equity line of credit (HELOC) to pay off your mortgage. The 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. This strategy isn’t right for every homeowner. Here’s what you’ll need to know to see whether you qualify and whether this strategy might be right for you.
How Does Using a HELOC to Pay Off Your Mortgage Work?
Before you start looking into a home equity line of credit, take a look at how you can use it to pay off your mortgage.
Say you own a $400,000 home and have $200,000 remaining on your mortgage. That means you have as much equity in your home as you do a loan. You can borrow against that equity to pay off your mortgage.
You’d then get interest payments calculated on today’s rates. Using this strategy could help you lower your payments and pay off your loan sooner.
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 620 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, make sure you meet these basic requirements.
Compare Lenders
Many lenders offer HELOCs. To get the best rates, compare multiple lenders to secure the loan amount you prefer. Ideally, you want one that will waive the closing costs or reduce upfront 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 steady income to repay the loan so be ready with pay stubs or tax filings for the last few years.
Get a Home Appraisal
To prove that you have adequate equity in your home to take the line of credit, you’ll need a home appraisal. Some lenders allow for virtual home appraisals, which are less expensive. But 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 the home or refinanced it, you’ll go through a closing procedure. This is when you sign on all the disclosures and information that make it clear what your interest rate is and the repayment terms you’ve agreed to. This will also outline the draw and 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 you now have 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’ll need to communicate with the lender to make sure 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 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.
When Should You Pay Your Mortgage with a HELOC?
The decision about whether to pay your mortgage with a HELOC comes down to interest rates. If your mortgage interest rates are above current HELOC rates, you might be better off using this strategy. But if your mortgage rate is fairly low, this won’t be a good strategy for you. Also be aware that HELOC rates are variable, meaning they’ll change throughout the loan and you could end up paying more in interest than you are estimating. To make the strategy viable you’ll need to secure a HELOC rate that is far lower than your current mortgage.
When Should You Not Use a HELOC to Pay Off Your Mortgage?
You should not use a HELOC when the numbers don’t add up. 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 at in your current mortgage term. The longer you’ve been paying your mortgage, the more of your monthly payment will be going toward your principal. That means that 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
Homeowners who qualify for a HELOC that is equal to or exceeds the value of their mortgage can use it to pay their mortgage off in full. Here’s a look at some of the pros and cons this strategy provides.
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 interest long term. The HELOC might have lower principal amounts required, which could also make your 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, which will also reduce the total cost of the loan.
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.
Variable rates: Most HELOC loans use variable rates. That makes it hard to know for certain that you’ll pay less in interest. And it can mess with your rates over the years while you work to pay it off.
Compare the Best HELOC Providers From Benzinga’s Top Mortgage Companies
Review these top providers to determine whether a HELOC loan might have better terms than your current mortgage.
- Best For:Online MortgagesVIEW PROS & CONS:securely through Rocket Mortgage (formerly Quicken Loans)'s website
- Best For:Flexible Mortgage OptionsVIEW PROS & CONS:securely through Angel Oak Mortgage Solutions's website
- Best For:Self-employed BorrowersVIEW PROS & CONS:securely through CrossCountry Mortgage's website
Lower Your Payments and Pay Off Your Home Faster
While it takes the right situation to make a HELOC worth it for a homeowner, those who it works for find that they pay far less in interest on their home with the opportunity to pay off the loan faster. Review your current mortgage terms to evaluate whether this is a viable option based on your financial needs.
Frequently Asked Questions
Is it possible to pay off a mortgage with a HELOC?
Yes, you can pay off a mortgage with a HELOC as long as you have enough equity in your home.
Is it smart to use a HELOC to pay off a mortgage?
In some instances, it is smart to use a HELOC to pay off a mortgage. You just need to make sure 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.
About Rebekah Brately
Rebekah Brately is an investment writer passionate about helping people learn more about how to grow their wealth. She has more than 12 years of writing experience, focused on technology, travel, family and finance. Her work has been published in Benzinga, Hearst Bay Area, FreightWaves and Dallas Observer publications.