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A home equity line of credit (HELOC) is an open-ended product that allows you to tap into your home’s equity as needed. Equity is the difference between what your home is worth and what’s remaining on the mortgage. You can withdraw HELOC funds and use them for any purpose, such as to make a large purchase, consolidate credit card debt, or pay off a mortgage.
Using a HELOC to pay off the mortgage on that same home means your HELOC replaces your mortgage as the first lien on the property. (Find out more about first-lien HELOCs.)
For many borrowers, this sort of debt replacement is possible. But is swapping one one home-secured debt with another the right decision? It might be, in certain situations.
In this guide:
- Why would I use a HELOC to pay off my mortgage?
- What are the disadvantages if I use a HELOC to pay off my mortgage?
- Will I pay off the debt faster with a HELOC?
- Does having a mortgage make it more difficult to be approved for a HELOC?
- What fees will I pay to use a HELOC to pay off my mortgage?
- What should I do if I want to use a HELOC to pay off my mortgage?
- Alternatives to using a HELOC to pay off my mortgage
Why would I use a HELOC to pay off my mortgage?
One of the biggest advantages of using a HELOC to pay off a mortgage is the potential to lower your overall interest rate while repaying your mortgage debt.
For example, say you’ve been paying down your 30-year mortgage loan for the last 15 years at an interest rate of 7.75% APR. Your home is now worth $450,000, but you still owe $190,000 on the loan, which you’re scheduled to pay over the next 15 years.
A HELOC could allow you to tap into at least a portion of your $260,000 in home equity (the difference between what your home is now worth and how much you still owe).
Many lenders will allow you to borrow a maximum loan-to-value ratio (LTV) of 70% to 90%. For this example, let’s say you choose a lender with a maximum LTV of 85%.
- A maximum combined LTV (CLTV) of 85% on a $450,000 property is $382,500 ($450,000 x 85%). This is the total amount you can owe between your original mortgage loan and your new line of credit.
- Since you still owe $190,000 to your first mortgage lender, your maximum allowed HELOC is $192,500 ($382,500 minus $190,000). So if you meet the lender’s eligibility requirements, you can open a line of credit for up to $192,500 against the property.
Now, imagine you get approved for a HELOC with an interest rate of 5.25%. In this case, you could take out the full $192,500 line of credit and use the funds to pay off your remaining $190,000 mortgage balance, closing out your original mortgage loan with its 7.75% APR.
You would then have two options for repaying the HELOC:
- Make interest-only payments on your HELOC for the rest of its draw period (often 10 years). This would allow you to direct the difference toward other financial goals. So if your original mortgage loan payment was $1,850 per month, and your interest-only HELOC payment is $400 per month, you now have $1,450 each month to put to other uses.
- Keep making your old monthly payment—$1,850—toward your HELOC. After all, you’re already used to that payment, and it’s part of your budget, so it may be easy to maintain. The benefit is paying off your HELOC ahead of schedule. Since the HELOC has a lower interest rate than your mortgage loan, you’ll also put more toward the principal balance each month.
The lower the interest rate on your balance, the less you’ll pay in interest over the same repayment period. But be aware that many HELOCs have variable, rather than fixed, interest rates.
What are the disadvantages if I use a HELOC to pay off my mortgage?
Before taking out a HELOC—especially if your goal is to use the funds to pay off and close out a mortgage loan—you need to understand the downsides to this type of debt.
The most significant potential disadvantage is that HELOCs’ variable interest rates can change based on the current market environment. Now, your rate can decrease and save you money, but it has the potential to rise during the repayment period, too.
If this happens, you could wind up with an interest rate even higher than your original mortgage loan, negating your efforts and increasing the overall cost to repay the borrowed funds. HELOC rates can change as often as every month, especially if the prime index rate changes often.
How can you combat this potential volatility?
- Pick a HELOC with a fixed rate: Not all HELOCs have variable interest rates. If you are worried about rates rising on a large line of credit and want to avoid a potential increase in out-of-pocket costs, choose a lender that allows for fixed interest rates. Your starting rate may be higher, but you’ll have peace of mind.
- Choose a HELOC that allows you to lock in rates: Some HELOCs give borrowers the option to “lock” their rate at certain points of the draw period though the overall rate is variable. If you plan to borrow a large chunk to pay off your home mortgage balance, you may be able to secure your rate just after opening the line of credit.
- Pay off your HELOC balance as soon as possible: The sooner you pay off your borrowed home equity, the less you’ll pay in interest, and the earlier you’ll get out of debt. Rather than pay just interest during your draw period, consider paying as much as possible toward your balance each month.
Another disadvantage when using a HELOC to pay off your mortgage is taxes. Certain borrowers may be able to deduct all or some of the mortgage interest they pay when they file federal income taxes. However, these deductions don’t include the interest paid on a HELOC in most cases.
If you live in a state or are in a situation that allows you to deduct mortgage interest from your taxable income, consider whether a HELOC would cost you more than it would save you. You could consult with a tax professional to run the numbers.
Will I pay off the debt faster with a HELOC?
All other factors the same, you will pay off a lower-interest debt faster than a higher-interest one if you make the same monthly payment. So what does this mean for HELOCs and mortgage loans?
If your mortgage payment is $1,500 per month, and your interest rate is 7.5%, you’ll pay less toward your principal balance than with a lower rate—5.5%, for instance. It will take longer to clear the principal balance and pay off your debt at the 7.5% rate.
If you continue making the same monthly payment to your HELOC as you did to your home mortgage lender, you should pay off your debt faster, as long as the interest rate on your HELOC is lower than on your mortgage loan.
Does having a mortgage make it more difficult to be approved for a HELOC?
Homeowners can’t borrow against 100% of their home’s equity through a HELOC. A remaining mortgage balance will reduce your HELOC limit by reducing your equity in your property.
Lenders often limit HELOCs to between 70% and 90% of your home’s total value, though factors including income, credit score, and location will further affect that amount. If your lender allows for an 85% LTV, you could borrow up to $340,000 against a home worth $400,000:
$400,000 x 85% LTV = $340,000 maximum total debt against the property
But if you have a remaining mortgage loan balance, your lender will consider CLTV instead. Your combined loan-to-value ratio considers all the liens against an individual property, including a mortgage, second mortgage, and home equity loan.
In the example above, if you are limited to a CLTV of 85% and have a remaining mortgage balance, you won’t be able to borrow the full $340,000 with your HELOC. Instead, the HELOC limit will be reduced by your remaining mortgage loan: If you owe your lender $115,000, you will have a maximum HELOC limit of $225,000:
$340,000 maximum – $115,000 remaining mortgage balance = $225,000 HELOC limit
Of course, lenders reserve their maximum CLTV for the most eligible borrowers. If your credit score or income are lower, your debt-to-income ratio (DTI) is higher, or you’re located in certain states, your HELOC limit could be lower.
This is where your current mortgage balance can come in. If you still have a monthly mortgage, that payment factors in to your overall debt obligation and—along with other monthly payments, such as an auto loan or credit card balance—can increase your DTI.
Most lenders require a maximum DTI or lower for HELOCs, so borrowers with a remaining mortgage are more likely to be denied than those without a mortgage.
What fees will I pay to use a HELOC to pay off my mortgage?
Shopping around can help you reduce fees or even avoid them altogether, so we recommend comparing several HELOC lenders to see which is best for you.
The most common HELOC fees include:
- Closing costs: Lenders charge closing costs to offset their administrative expenses. These can include application and origination fees and costs for credit checks.
- Appraisal fees: Depending on your lender, your home’s value, and when you purchased the property, you may need a new appraisal before you take out a HELOC. If it’s necessary, your lender will order the appraisal, but it might pass the cost on to you.
- Annual fees: Many lenders charge annual fees for HELOCs, even if you don’t borrow from the line of credit. Lenders may waive these fees if you meet other requirements, such as maintaining a checking account through the same bank.
- Early payoff penalties: If you pay off and close out your HELOC within a certain time (often three years) of opening the line of credit, your lender may charge penalty fees. This is most common if your lender pays the closing costs.
What should I do if I want to use a HELOC to pay off my mortgage?
First, you’ll want to determine whether you have enough home equity to cover your current mortgage balance. This involves looking at your home’s value and how much you still owe on the property.
One first step is contacting your current lender for a payoff quote. That number will tell you how much you need to borrow against a HELOC and can help you calculate your home’s current equity based on its present market value.
You can then begin searching for the right HELOC lender. Rate shopping is the best way to ensure you get a line of credit at the lowest possible interest rate and with the best terms and fees. Shopping around can also help you find a lender with the highest LTV limit, so you can borrow as much as you need to pay off your mortgage balance.
Alternatives to using a HELOC to pay off my mortgage
Not sure if a HELOC is the right choice to pay off your mortgage balance?
Alternatives include the following:
- Home equity loans: Similar to a HELOC, a home equity loan allows you to borrow against a portion of your home’s available equity in one lump sum. While LTV limits are often similar to HELOC limits, home equity loans have one major benefit: fixed interest rates. In a time of unpredictable rate trends, anticipating your home equity loan payments can offer peace of mind.
- Mortgage refinance loan: Another option is to replace your current mortgage with a new refinance mortgage loan. Depending on your existing loan, current rates, and your goals, you may be able to reduce your interest rate, adjust your monthly payment obligation, remove a co-borrower, or a blend of the three.
Author: Stephanie Colestock