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Homeowners who have built up a nice amount of equity in their home, typically through a combination of regular mortgage payments and growth in home value, are often candidates for a home equity line of credit (HELOC). And if you have a HELOC or are thinking of getting one, it’s natural to think, should I use my line of credit to pay off my mortgage?
The answer is maybe…but. There are plenty of complexities involved in paying off a home loan with a HELOC, and for many people it may not be a sound move. Learn more about this approach here.
Key Points
• Using a HELOC (home equity line of credit) to pay off a primary mortgage involves significant complexities and is generally an uncommon choice for homeowners.
• While paying off a mortgage with a HELOC may temporarily reduce monthly payments, it can substantially increase your cost in the long run.
• It might make sense only in rare scenarios, such as when HELOC interest rates are lower than a homeowner’s mortgage rate, or during a short-term cash crunch.
• The primary risk of this approach is potential foreclosure if you can’t afford the higher principal-and-interest payments during the repayment phase.
• Alternatives to using a HELOC to pay off a mortgage include a mortgage refinance or making extra payments toward the mortgage principal to retire debt more quickly.
How Using a HELOC to Pay Off a Mortgage Works
To understand how you might pay off a mortgage with a HELOC, first refresh your grasp of HELOC basics. A HELOC is a line of credit, but it is also, technically, a second mortgage on your home (assuming you’re still paying off your first mortgage). You’ll have a period of time, often a decade, during which you can draw on the credit line. Borrowers are typically required to pay interest only during this draw period.
After the draw period ends, borrowers enter the repayment period. You make monthly payments against the principal, plus interest, until the HELOC is paid off. HELOCs typically have variable interest rates, versus the fixed rates that are common with home loans.
It’s worth noting that a HELOC is not the same thing as a home equity loan. A home equity loan is a lump-sum loan. Again, your home is the collateral for the loan. With a home equity loan, you begin making principal-plus-interest payments immediately after receiving funds.
If you pay off your mortgage with your HELOC, you’ll have to pay interest on the HELOC balance until the draw phase ends. And if the interest rate on your HELOC is higher than that on your original mortgage, you could actually end up paying more interest if you use your HELOC to pay off your mortgage, even if your monthly payment during the draw phase is less than you were paying for your mortgage payment.
Recommended: Modifying Your HELOC
Pros and Cons of Paying Off a Mortgage with a HELOC
It’s pretty unusual to use a HELOC to pay off a large debt, so it’s unlikelier still that a homeowner would pay off a mortgage with a HELOC. Let’s take a look at the pros and cons of taking this approach to understand whether there are any situations where it might be a wise move.
When It Might Make Sense
One situation in which it could be a solid option to pay off a home loan with a HELOC is if current HELOC interest rates are noticeably lower than the interest rate you have on your first mortgage. This would be an unlikely scenario, however, as 30-year mortgage rates have rarely exceeded 8.00% in the last 30 years, and current HELOC rates are over 7.00%. But in some cases it might be possible.
Another scenario in which it could make sense to pay off your home loan with a HELOC is if you need to reduce your monthly payment amount. If making the interest-only payment on your HELOC would be less costly than making your mortgage payment, paying off the home loan with the HELOC could temporarily save you money. However, it will likely cost you more in interest in the long haul. But if you’re in a short-term cash crunch and you feel confident you can make your HELOC payments when the draw phase ends, this could be a solution.
Finally, if you feel confident that you are on track to receive a sum of money that would allow you to pay off your HELOC early (before the draw phase ends) after using the line of credit to pay off your home loan, then it could make sense to pay off the mortgage. Check first to see if an early mortgage or HELOC payoff will result in any financial penalty, as you would want to factor that into your calculations.
Risks to Consider
The primary risk associated with using a HELOC to pay off a mortgage is the risk associated with using a HELOC for any purpose: Your HELOC is secured by your home, and if you can’t make your monthly HELOC payments, you risk foreclosure. When you’re in the interest-only draw phase of a HELOC, interest payments might be affordable. But you’ll want to be sure you can afford the higher principal-plus-interest payments when the repayment phase comes.
You can use a HELOC repayment calculator to run the numbers to see what your payments might be like during the repayment phase. However, remember that most HELOCs have variable interest rates, so the interest rate on your HELOC could go up.
If you’re thinking of opening a HELOC to pay off your mortgage, another risk to consider is that once you have a line of credit available, you might use it for other expenses in addition to the mortgage payoff. You can use a HELOC for many things, and if you have trouble managing credit, opening a line of credit could cause you to take on more debt than you can handle.
Recommended: Keeping Your HELOC When You Refinance
HELOC vs Refinancing to Pay Off a Mortgage
If you’re not enthusiastic about using a HELOC to pay off your mortgage, you might consider taking a path that more homeowners choose: a mortgage refinance. With a refinance, you get a new loan, with a new repayment term and new interest rate, and your old loan is paid off.
Refinancing could be an appealing option if the interest rate on your existing mortgage is higher than current refinance rates. Some people also refinance into a longer term to give themselves more time to pay off their mortgage. This could reduce the size of your monthly loan payment, although it usually means paying more interest over the life of the new loan.
Opening a HELOC and refinancing can both involve paying fees. You’ll want to factor this in if you are considering a HELOC vs. refinancing.
Other Alternatives to Consider
Maybe you like the idea of a refinance but also want the flexibility of having access to extra funds, as you would with a HELOC. In that case, there’s another option to consider: a cash-out refinance. With a cash-out refi, you take out a new home loan for an amount that is greater than what you owe on your original mortgage. With the new loan, the original mortgage is paid off. The remaining cash is deposited into your account to use as you wish. This might be a good option if you need extra funds for renovations, for example, and you can obtain an interest rate on the new loan that is lower than the rate you had originally.
Of course, any type of refinance still leaves you making payments on a mortgage. So if your goal is to get rid of home loan payments, you might consider making extra payments on your existing mortgage to retire your debt sooner. Paying off your mortgage early could lower the overall cost of interest on your loan. If you have your financial house in order — you have an emergency fund, can pay all your bills, and are saving for retirement — and still have funds left over, you could make extra payments toward the principal on your home loan.
Making extra loan payments is only sensible if you don’t have other debts that have a higher interest rate than your mortgage. It might be appealing to zero out your home loan, but if you are carrying credit card debt, consider directing extra funds to that first.
The Takeaway
Using a HELOC to pay off a mortgage is an unusual choice, and with good reason: For most people, the interest rate on a HELOC could be greater than that on a home loan. And while using your HELOC to pay off your home loan could temporarily lower your monthly payments, when you hit the repayment phase on the HELOC, you could find yourself paying far more than you paid toward your mortgage.
That said, there are some specific circumstances in which it could make sense to pay off a mortgage with a HELOC, and having a HELOC can be useful if you also need to cover other ongoing expenses, such as renovation costs or medical bills. One solid first step if you’re thinking about a HELOC is to explore interest rates and terms from prospective lenders.
SoFi now offers flexible HELOC options to turn your home equity into cash. Access up to 85% of your home equity, or $750,000, to finance home improvements or consolidate debt. Competitive interest rates and repayment terms up to 20 years could result in lower monthly payments versus other loans. And the online application process is quick and convenient.
Unlock your home’s value with a home equity line of credit from SoFi.
FAQ
Is HELOC interest tax deductible if the HELOC is used to pay off a mortgage?
HELOC interest may be tax deductible if the HELOC is used to pay off the mortgage on the home that secures the HELOC. HELOC interest is deductible when it is used to buy, build, or substantially improve your home. You’ll want to talk with a tax advisor to make sure you qualify for this deduction.
What credit score do you need to use a HELOC to pay off a mortgage?
You don’t need a particular credit score to pay off your home loan, but you will need a credit score of around 680 to qualify for a home equity line of credit (HELOC). Some lenders will approve borrowers with a score below 680, but many will require 680 or better.
Can a HELOC help you pay off your mortgage faster?
Having a home equity line of credit won’t help you pay off your mortgage faster unless you use the HELOC to pay your mortgage. However, using a HELOC to make mortgage payments could significantly increase the overall amount of interest you will pay on your home. And if you pay off your mortgage with a HELOC and then can’t make your HELOC payments, you risk losing your house to foreclosure.
How does a HELOC affect your debt-to-income ratio?
When you have a HELOC, your debt-to-income (DTI) ratio will increase if you use your line of credit. This is because your DTI is your total monthly debt payments divided by your gross monthly income.
What happens to a HELOC after your mortgage is paid off?
If you have a home equity line of credit (HELOC) and pay off your mortgage, your credit line should continue to be available to you as long as you still own your home. If you pay off your mortgage as part of a home sale, you’ll likely need to pay off and close out your HELOC as well.
Photo credit: iStock/Thitiphat Khuankaew
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