Should you use a HELOC to pay off your mortgage?

Many homeowners today are sitting on significant equity in their homes: As of Q2 2023, the average mortgage holder now has$199,000 in equity, according to Black Knight, which tracks real estate data. 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 the remaining balance is fairly small.

Here’s what to know about paying off your mortgage with a HELOC, — and the risks that come with this strategy.

Paying off your mortgage early with a HELOC

A home equity line of credit (HELOC) is a flexible line of credit that allows you to leverage — that is, borrow against — your equity, the percentage of your home you own outright.  Based on your equity level, you’ll be approved for a certain amount — similar to the credit line on a credit card — which you can tap during the HELOC’s draw period, which typically lasts 10 years. After that draw period, you’ll need to repay what you borrowed (with any interest owed), usually over a 20-year time frame.

You can use these funds for any purpose, including mortgage payments. So with this strategy, essentially you’re using your ownership stake in your home to pay off what you still owe on your home. But you’ll then have your HELOC debt to repay.

If you could get a significantly lower rate on a home equity line of credit than you currently have on your home loan, using a HELOC to pay off a mortgage can make a lot of sense. In the current high interest rate environment, though, you probably want to wait before deploying the HELOC strategy.

How to use a HELOC to pay off your mortgage

1. Shop for a competitive rate

If you’re considering the HELOC strategy to pay off a mortgage, it all comes down to rates. Evaluate different options and investigate what HELOC rate you qualify for. Compare the rates and terms available against your current mortgage to determine whether you would benefit from taking this step. Remember, HELOCs come with variable rates, so you want a big margin with room for upward direction.

2. Apply for a HELOC

If you find a HELOC with a favorable interest rate and terms, go ahead and  apply. Typically, you will need at least 15 to 20 percent equity in your home, a credit score in the mid-600s, and a debt-to-income ratio of 43 percent or less to qualify for a HELOC.

3. Receive your HELOC funds

Expect a processing time of between two and six weeks from when you apply to when you receive access to your line of credit. Once you can access your line of credit, you can borrow against the available equity in your home either over your HELOC’s draw period or all at once.

4. Pay off your mortgage and maintain regular HELOC payments

Assuming you qualify for enough of a HELOC to pay your mortgage balance off in full, you can do so as soon as you have access to your home’s equity. Keep an eye out for documents confirming the closure of your mortgage loan, and focus on staying current with HELOC payments moving forward.

When to pay your mortgage with a HELOC

There’s no equity limit or percentage of your remaining loan to pay down that indicates you should use the HELOC strategy to pay off a mortgage. Instead, it all comes down to interest rates.

You should only pay off a mortgage with a HELOC if you can get a significantly better interest rate on the line of credit than you currently have with your mortgage. Because the HELOC’s rate is variable, it needs to be much lower than your mortgage rate — with room to move upward before you hit that rate — for this move to make financial sense. And because HELOCs generally have higher rates than mortgages, you might be hard pressed to make this math work.

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

Prepaying your mortgage can certainly save you money in the long run. However, using a home equity line of credit to do so has limitations.

First of all, lenders typically only allow you to borrow up to 80 percent (sometimes 85 percent) of your equity in your home as a line of credit. Depending on your specific financials, this might not be enough to pay off your mortgage entirely.

Secondly, whatever funds you use from the HELOC need to be paid back: The repayment period typically lasts 20 years. If you’re close to paying off your current mortgage, you might not want to commit to repaying another debt over two more decades, especially if you’re nearing or in retirement and on a fixed income. (Of course, there’s no law that says you can’t settle the HELOC balance early, though there may be a prepayment fee to do so.)

But the biggest reason to pause: interest rates. Although they both use your home as collateral, HELOCs tend to be a more expensive form of financing. Currently, their interest rates are hovering around 7.5 percent, compared to 7.31 percent for the average 30-year mortgage. Also bear in mind that, unlike mortgages, most HELOCs have fluctuating interest rates — and rates have been on the rise since 2022, reflecting the Federal Reserve’s series of rate hikes to contain inflation.

That means interest rates on an older mortgage may remain competitive against a HELOC taken out today. “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 [new] HELOC would actually be lower than a mortgage acquired in the past 20 years.”

Pros and cons of using a HELOC to pay off a mortgage

Benefits of using a HELOC to pay off your mortgage

• 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. You can also withdraw different amounts at different times.
• Low or no closing costs: Although HELOC closing costs can range from 2 percent to 5 percent of the amount you’re borrowing (similar to a mortgage), some lenders offer no-closing-cost HELOCs. The cost of borrowing this money might be lower than other options you might be considering, like a cash-out refinance.
• 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.

Risks and downsides of using a HELOC to pay off a mortgage

• 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 you can pay off a mortgage with a HELOC, 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 off what you borrow sooner than the repayment schedule dictates.
• Tax disadvantage: If you itemize, your mortgage interest is tax-deductible. Your HELOC’s interest may not be if you’re using it for this purpose — generally, you’d need to be using the funds to  “buy, build, or substantially improve the home.” Definitely check with a tax pro.

Alternatives to HELOCs to prepay or pay off a mortgage

If your goal is to repay your mortgage early, in the current interest rate environment, you’ll likely be better off making extra payments, if possible. You might opt to pay extra in a lump sum, or begin making biweekly payments. Even one more payment a year can speed up the payoff process.

Or, if you need to borrow the funds, consider taking out a home equity loan to pay off your mortgage. 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, especially with interest rates as high as they are right now. You’ll also incur closing costs, as a home equity loan is a second mortgage.

How to qualify for a HELOC

Most lenders require you to have at least 20 percent equity in your home before you can apply for a HELOC. They also generally want to see a credit score of at least 650 and a total debt-to-income ratio at or below 43 percent.

The better your financial profile, the lower the rate you’ll get with your HELOC.

Using a HELOC to pay off other debts

If you decide to use the HELOC strategy to pay off your mortgage and you won’t hit the limit on the line of credit to settle your home loan, you can use the extra money any way you want.

That includes paying off other types of debts. Again, the pros and cons here all come down to interest rates. If you use the HELOC to pay off credit card debt with a higher interest rate, that makes good financial sense. But if you use it to pay off debt with a lower interest rate (e.g., student loans), you’ll pay more in the long run.

The bottom line on using a HELOC to pay your mortgage

A home equity line of credit is a powerful resource in your toolkit for consolidating debt. While you may decide that your home’s equity is best used paying off your current mortgage, be sure to crunch the numbers. The key factors here are the rate you could get on the HELOC and your mortgage interest rate. There are many financial goals a HELOC can help you to achieve, but it’s important to weigh the pros and cons, before exchanging one kind of debt for another.

Additional reporting by Kacie Goff