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Should you use a HELOC to pay off your mortgage?

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Despite changes in the housing market, many borrowers today have significant equity in their homes. If you’re one of them, you might be wondering if it makes sense to use a home equity line of credit (HELOC) to pay off your mortgage — especially if you don’t owe very much on your home. Here’s what to know about paying off your mortgage with a HELOC, and the risks that come with doing so.

Can a HELOC help you pay off your mortgage?

It’s possible to use the funds from a HELOC to help pay down your mortgage. If you have a lot of equity in your home and don’t have much left to pay on your loan, you might even be able to pay it off completely with the line of credit.

HELOCs work by allowing you to leverage your home’s equity to get funds for any goal or purpose, such as home improvements, tuition or even emergencies. Based on your equity level, you’ll be approved for a certain amount, which you can borrow some or all of during the HELOC draw period, typically 10 years. During this time, you’ll pay interest on what you borrow, at a variable rate. After the draw period, you’ll need to repay what you borrowed (with any interest owed), usually over a 20-year time frame.

Pros and cons of using a HELOC to pay off mortgage

Pros

  • Chance for a lower rate: If your current mortgage has a higher interest rate and the HELOC has a lower rate, you can use the funds from the HELOC to pay off your mortgage sooner for less. This depends largely on the broader mortgage market, however — right now, rates are rising on all types of loans, including HELOCs. Compare current HELOC rates.
  • Flexibility: HELOCs are a more flexible form of financing in that you can borrow only what you need versus the entire amount you were approved for. For instance, if you don’t want to use all of the HELOC funds to pay down your mortgage, you might decide to devote some of the money to home renovations or other expenses, or not borrow it at all.
  • Low or no closing costs: Although HELOC closing costs generally range from 2 percent to 5 percent of the amount you’re borrowing (similar to a mortgage), the expense might be lower compared to a cash-out refinance, since you’re likely borrowing less. Some lenders even offer no-closing-cost HELOCs.

Cons

  • Variable rate: HELOCs come with a variable interest rate, which means your rate will fluctuate over time based on market conditions. There’s no way to predict whether your rate will move up or down in the future, so you’ll need to be prepared to fit higher payments into your budget.
  • More debt: While the HELOC might pay down your mortgage, you’d also be replacing that debt with another form of debt, and you might end up paying more interest than you would have with your current mortgage. This has implications for your credit score and finances — especially if it’s not helping you save money in the long run.
  • Fees and penalties: Many HELOCs have an annual fee, and some come with a prepayment penalty if you pay it off sooner than the repayment schedule dictates.
  • Flexibility: The flexibility of a HELOC might also be a downside in that it might tempt you to spend the funds impulsively or otherwise overextend yourself financially.

Example of using a HELOC to pay off mortgage

Let’s say 20 years ago, you took out a $300,000, 30-year mortgage with a 6.5 percent rate. Today, your remaining balance is $164,107, and your home is currently worth $675,000. That means you have $510,893 in equity. You’d only need to borrow about 30 percent of that with a HELOC to pay off your mortgage balance.

Is it a good idea to pay off mortgage early with a HELOC?

While you can use a HELOC to help pay your mortgage, it has limitations. HELOC lenders typically only allow you to borrow up to 80 percent (sometimes 85 percent) of your home’s value as a line of credit. Depending on your specific financials, this might not be enough to pay off your mortgage entirely.

Whatever funds you use from the HELOC also need to be repaid, usually in a repayment period of up to 20 years. If you’re close to paying off your current mortgage, you might not want to commit to repaying another debt over several more years, especially if you’re nearing or in retirement and on a fixed income.

The variable rate is also reason enough to pause. The Federal Reserve has indicated it intends to keep raising its key rate in 2022, which means loftier rates on HELOCs.

“Variable-rate HELOC customers could easily see their interest rates rise significantly,” says Herman (Tommy) Thompson, Jr., CFP, of Innovative Financial Group in Atlanta. “It’s also unlikely that the interest rate on a HELOC in 2022 would actually be lower than a mortgage acquired in the past 20 years.”

Alternative ways to prepay or pay off your mortgage

If your goal is to repay your mortgage early, you might be better off making extra payments, if possible, or as an alternative, taking out a home equity loan. When making additional payments, you might opt to pay extra in a lump sum, or begin making biweekly payments. With a home equity loan, you’ll get a fixed rate (versus a variable rate with a HELOC), which means your monthly payments won’t change. However, you’re still borrowing money to pay off borrowed money, which isn’t ideal. Consider this and a HELOC carefully if you’re looking to get rid of your mortgage sooner.