Should you pay off your mortgage with a HELOC?

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Should you pay off your mortgage with a HELOC?

A home equity line of credit (HELOC) can be an attractive option for homeowners who want to access a flexible, low-cost line of credit.

Some homeowners use HELOCs to cover financial emergencies and big-ticket items; others consolidate debt to make the balances more manageable. But what about using a HELOC to pay off your mortgage faster and enjoy lower monthly payments? Is it a good idea? Read on to learn the pros and cons of using a HELOC to pay off your mortgage as well as alternatives.

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A HELOC works like a credit card. It’s a revolving line of credit that lets you borrow against your home equity, which is the difference between what your home is currently worth and how much you owe on your mortgage. You can pull funds during what’s referred to as the draw ******* — it typically lasts up to ten years.

Most lenders only require interest-only payments while the line is open. The interest rate is variable, though, so the monthly payments fluctuate. Once the draw ******* ends, payments increase to reflect both principal and interest.

Learn more: How do fixed-rate HELOCs work, and which lenders offer them?

While most homeowners commonly use HELOCs for big-ticket expenses and debt consolidation, some use HELOCs to repay their mortgages early.

Flexibility: You can withdraw funds as needed and use them however you see fit.

Controlled costs: You only pay interest on the funds you withdraw, giving you more control over borrowing costs.

Competitive rates: You may get a lower rate than you would with other refinance options, or, in some instances, a traditional mortgage.

Interest-only payments: Only paying interest during the draw ******* makes HELOC payments more affordable.

Minimal closing cost: You can expect minimal closing costs on HELOCs.

Variable rates: Most HELOCs come with variable interest rates, so monthly payments fluctuate during the draw and repayment periods.

Prepayment penalties: Some lenders assess prepayment penalties if you pay a HELOC off early.

Fees: Some lenders charge origination fees, annual fees, and dormancy fees on HELOCs.

Risk of foreclosure: A HELOC is secured by your home, so you could lose it to foreclosure if you default on the payments.

Learn more: What to expect when facing foreclosure

If you choose to pay off your mortgage with a HELOC, keep these general guidelines in mind:

Equity: You should have at least 15% to 20% in home equity. More equity could mean access to a larger HELOC.

Credit score: Most lenders prefer a credit score of 680 or higher; 700 is even better. A strong credit score also helps you access more competitive rates.

Income: Lenders want reassurance that you can afford to repay the HELOC. So, consistent, verifiable income is required to qualify.

Debt-to-income (DTI) ratio: This is the percentage of monthly income spent on debt obligations. Aim for a DTI ratio below 43%.

Insurance: Lenders generally require proof of homeowners insurance.

Research several lenders and create a shortlist of those you may want to do business with. Get prequalified with at least three lenders and compare quotes to find the best fit. The amount you qualify for should be enough to pay off your mortgage balance.

Read more: Best HELOC lenders

Gather the required information and documentation. Once you’ve done so, formally apply with your chosen lender.

Step 3: Get approved and funded

The timeline from application to closing varies by lender. Upon approval, funds are generally deposited electronically into your bank account.

Initiate a HELOC withdrawal to cover your home loan’s outstanding balance. Pay your lender directly to satisfy your mortgage debt and begin making HELOC payments as they come due.

Your mortgage balance is low.

You want lower long-term housing costs.

You want to shift your focus to other financial goals.

You can qualify for a better rate than you currently have.

You want to stop paying mortgage insurance.

You plan to move soon.

You’re almost to the end of your mortgage term.

Your lender assesses hefty prepayment penalties.

You don’t plan to relocate in the foreseeable future.

You have a much lower rate with your current mortgage.

A mortgage refinance lets you swap out your current loan with a new one, preferably with a lower interest rate and shorter term. Or you can opt for a cash-out refinance. Like a traditional refinance, it lets you swap out your current mortgage. But the new home loan is larger and includes any equity you’ve built up. You’ll receive the difference between the new loan and what you owe in cash.

Similar to a HELOC, you can borrow against your home equity with this option. But there are a few key differences between the two. With a home equity loan, you receive a lump sum and are responsible for paying interest on the entire amount. Home equity loans also come with fixed interest rates, and you can expect closing costs.

A mortgage recast is also an option if you’re sitting on a large sum of cash. You’d make a large payment toward the principal and ask the lender to re-amortize the remaining balance. The end result: lower monthly mortgage payments without modifying your loan terms. This service comes at a cost, though.

Considering paying your mortgage off early but not right away? Paying extra each month could be more viable and cost-efficient. You could double up if there’s room in your spending plan or pay whatever extra you can each month. Biweekly payments are also smart, as they equal an extra monthly payment annually.

If you’re at least 62, you can use a reverse mortgage to wipe away home loan debt. It pays off your mortgage, and you receive the equity in a lump sum, monthly installments, or as a line of credit. But you don’t have to make payments to the lender. Instead, ownership of the home transfers to the lender if you decide to sell, relocate, or pass away. That’s unless the balance, including any accrued interest, is paid in full.

Learn more: HELOC vs. reverse mortgage vs. home equity loan — which one is best?

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