Should you use a HELOC to pay off your mortgage?

If you have equity built up in your home, you may consider using a home equity line of credit (HELOC) to lower your monthly payments or the overall interest paid on your mortgage. HELOCs often have lower interest rates than traditional mortgages. The potential is to save money and pay off your mortgage faster by using a HELOC.

When rates on your current loan and HELOC are similar, homeowners often ask, "Should you use a HELOC to pay off your mortgage?" Using a HELOC to pay off your mortgage versus a traditional refinance could still be advantageous.

What is a HELOC?

A HELOC functions similarly to a credit card. You receive a maximum amount you can borrow, and you can use as little or as much of this amount as you like. Unlike a credit card, the amount you can get is based on the equity you have in your home, which is the difference between your home's current market value and the amount you still owe. Also, a HELOC has a set time in which you can draw from it, usually in the 10- to 15-year range.

One advantage of a HELOC is that you can usually access far more funds than you could with a credit card and at a much lower interest rate. The interest rate on a HELOC tends to be around 5.5% on average, while the average interest rate for credit cards is three times higher at about 17%. HELOCs can also offer tax benefits in certain situations, such as making home renovations or paying off your mortgage.  Please consult your tax advisor regarding interest deductibility as tax rules may have changed.

Using your HELOC to pay off your home's mortgage

Typically, a lender will allow you to borrow 80% to 85% of your home's value, subtracting what you owe on your mortgage. If you're going to use your HELOC to pay off the remaining balance of your mortgage, make sure you have sufficient equity in your home to qualify for a HELOC large enough to cover the balance.

For example, let’s say you have a home with a current market value of $200,000 and have a mortgage balance of $75,000. In this scenario, you would have equity of $125,000. If the lender allows you to borrow 80% of your home's value total, you can have a combined loan balance of $160,000, giving you a maximum HELOC credit line of $85,000.

To pay off your mortgage in this situation, you would take at least $75,000 and submit this amount to your mortgage company, paying off the primary mortgage in the process. You have an option to make interest-only payments for the remainder of the draw period, or you can start paying down the principal as well. Typically, the interest rate on a HELOC is based on the federal interest rate. However, you could lock in your interest rate, so discuss this option with your lender.

Is a HELOC your best option for paying off your mortgage?

You're essentially refinancing if you use a HELOC to pay off or pay down your mortgage. A HELOC allows you to reduce your payment or interest rate without the associated closing costs of a traditional refinance. Before you decide on a HELOC to pay off your mortgage, you should consider the following:

• How much do you owe on your current mortgage?
• How long will it take you to pay off your existing mortgage?
• What are your current monthly payments on your mortgage?
• What is your HELOC borrowing limit?
• What will the monthly payments be on a HELOC?
• Can you pay interest only during the draw period?
• Are you self-disciplined enough to make additional payments toward the HELOC principal?
• Will you have any interest savings using a HELOC versus a traditional refinance?

The answers here will help you with the question homeowners ask, "Should you use a HELOC to pay off your mortgage?"

Advantages of getting a HELOC to pay off your mortgage

If your credit standing is good enough to qualify for an attractive interest rate, and you select the correct option to suit your needs, using a HELOC to pay off your mortgage could be helpful. For starters, you can ultimately end up paying less overall. Interest will continue to accumulate the longer you have a mortgage with an outstanding balance.

While you'll still pay interest on a HELOC, you may be able to get a rate that's significantly less than what you're currently paying on your mortgage. If you can get a better rate, you'll accrue less interest. You may also be able to get a shorter term, allowing you to pay off what you owe faster and save on the interest that way.

Another advantage of obtaining a HELOC to pay off your mortgage is using the HELOC money for other things. In our example, you only needed $75,000 of the possible $85,000 to pay off the mortgage. You can use that extra money to update your bathroom or kitchen, thereby increasing the value of your home, giving you even more equity. Using the HELOC for home renovations or improvements may be tax-deductible, yet another advantage to you as a homeowner. 

Potential issues from using a HELOC to pay off your mortgage

As with anything, using a HELOC to pay off your mortgage isn't without unfavorable factors. Make sure you analyze and consider everything that will result from this decision, good and bad. One consideration is that you haven't changed the amount you owe. You're not saving money on the principal of the mortgage. You have, in essence, just transferred the balance from a traditional mortgage to a HELOC.

In our example, either way, you'll still have $75,000 to pay off your mortgage, regardless of whether you use a HELOC or keep the current mortgage. Remember that your home still serves as collateral for your HELOC, just like your mortgage. Failing to make timely payments on your HELOC can also result in your lender foreclosing and you could lose your home.

Final thoughts about home mortgages and HELOCs

Using a HELOC to pay off your mortgage balance is a reasonably simple process. If you have solid credit and sufficient equity, you'll need to apply, get approved, draw the money, and send it to the mortgage lender. If you're a homeowner with equity above the remaining owed, you may be able to get a lower interest rate on a HELOC than you currently have on your mortgage or reap the benefits of excess equity. You can use some extra money to make further improvements to the property. If this arrangement sounds like your situation, it may be time to investigate getting a HELOC and paying off your home mortgage.

Want to learn more about HELOCs? Read these additional articles:

• How does a HELOC work?
• Paying for a big expense: personal loan, HELOC, or card