A home equity loan or line of credit (HELOC) adds to your monthly budget, but your payments are separate from your mortgage.
It’s possible to strategically use your home equity to lower your overall mortgage payments, but the numbers must make sense in your situation. We’ve researched home equity loans and HELOCs, including how they affect your overall housing costs.
In this guide:
- How does a home equity loan affect your mortgage payment?
- How does a HELOC affect your mortgage payment?
- How to determine whether you can afford a home equity loan or HELOC and your mortgage
How does a home equity loan affect your mortgage payment?
Two financing options let you access the equity in your house: a home equity loan and a HELOC.
A home equity loan is an installment loan, which means you borrow a one-time sum and make monthly payments for a set period. Interest rates are often fixed, so your monthly payment is the same.
Depending on your lender and how much you borrow, your home equity loan term could last five to 20 years.
How home equity loan repayment works
One benefit of choosing a home equity loan is that the fixed characteristics—interest rate and loan term—make budgeting predictable.
But does a home equity loan increase your mortgage payment?
No, a home equity loan is considered a “second mortgage.” It’s an entirely separate loan from your primary mortgage. You need to manage both payments, even with the same lender.
How does a HELOC affect your mortgage payment?
Now let’s explore another option for accessing your home equity. Just like a home equity loan, a HELOC is separate financing from your regular mortgage.
A HELOC acts more like a credit card than a loan. You can borrow as needed from your credit limit. Repaying your balance replenishes the credit line, and you can borrow the funds again throughout the draw period.
Here’s how HELOC repayment works: During the draw period, you’re often only required to make interest payments. Your rate may be fixed or variable, depending on your HELOC terms.
Once the draw period ends—usually five to 20 years—you’ll enter the repayment period. This can last another 10 to 20 years, and you’ll pay principal and interest on your HELOC balance in addition to your mortgage payment.
If you’re nearing the end of mortgage repayment
A HELOC can affect your mortgage payment in specific scenarios.
One option to strategically use a HELOC is when you’re near the end of your mortgage repayment period. You could use the HELOC funds to pay off your mortgage balance and then make payments on your HELOC to take advantage of potential savings.
This situation involves several variables, and you should ensure your numbers make sense before deciding. Let’s see an example of when this strategy would make financial sense.
Imagine you’ve owned a home for 25 years with the following terms:
|Home purchase||Length of mortgage||Mortgage balance at time of home purchase||Interest rate||Monthly payment|
|25 years ago||30 years||$175,000||6%||$1,049|
After 25 years of payments, your remaining balance is about $37,000.
You could use a HELOC to pay off the mortgage balance of $37,000. At a 7% rate, instead of a $1,049 mortgage, your HELOC payment would come to $733 per month for the next five years. However, because many HELOCs include variable rates and not fixed, the rate may be subject to change unless you can lock in your HELOC rate.
If the time it will take to pay off your mortgage exceeds your HELOC draw period
HELOC payments can increase after the draw period ends because you go from interest-only payments to total payments on your balance.
If your draw period ends while you still have payments left on your mortgage, it could become a significant financial strain. It’s crucial to know you’ll be prepared.
Let’s say you take out a HELOC with a 10-year draw period and a 10-year repayment period. You have 15 years left on your original 30-year mortgage.
|HELOC balance||Variable HELOC rate during draw period||Monthly payment during draw period (interest-only)||Variable HELOC rate during repayment period||Monthly payment during repayment (principal + interest)|
Throughout the HELOC, the interest-only payment was $200 per month. Now, rates have risen, and the APR is 8%. Since you’re paying the balance and interest, the monthly payment jumps to $485 for the next 10 years—and you must make mortgage payments as well.
Consider what you’ll owe during the repayment period before taking out a HELOC. Add it to your remaining mortgage payments to ensure it feels affordable.
How to determine whether you can afford a home equity loan or HELOC and your mortgage
When deciding whether home equity financing makes sense on top of your mortgage, take into account:
- Closing costs: Home equity loans and HELOCs may have associated costs, such as appraisal and lender fees.
- Annual maintenance fee: Certain HELOCs charge a service fee each year.
- Variable interest rates: Home equity loans are often fixed, but HELOCS could have variable rates, which can cause payments to change.
Consider which structure would be better for your financial needs: a home equity loan that gives you one-time funding or a HELOC that lets you draw funds multiple times.
If your monthly budget is already tight, you may not be comfortable taking on additional debt, especially if you have several years of mortgage payments ahead.
Will a home equity loan or HELOC affect any other part of a mortgage besides the payment?
No. Your mortgage terms are locked in regardless of getting a home equity loan or HELOC. The only way your terms change is if you refinance the loan.
Will my mortgage and home equity loan or line of credit be two separate payments if I use the same lender?
Even if you use the same lender, your mortgage will always be a separate loan from any type of home equity financing.
With a unique interest rate and repayment terms, your mortgage is considered the primary lien on the house over other types of debt that use the home as collateral.
Therefore, you’ll have two separate payments for your mortgage and home equity loan or HELOC, even if you use the same lender.