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If you’re like many homeowners, you’re probably sitting on a lot of home equity right now and wondering if you can put it to good use.
“People have much more capital than they have [had] in the past,” says Matthew Locke, national manager of mortgage sales for UMB Bank. Home value growth in 2021, fueled by rising home prices amid a competitive housing market, outpaced median wages in 25 of 38 major metropolitan areas, according to real estate market Zillow.
Financing home renovations and consolidating debt are two tried and true uses for your home equity, but what if you want to use them to pay off your primary mortgage?
It’s possible to use a home equity line of credit (HELOC) to pay off your mortgage, but it depends on how much equity you have and how large your remaining mortgage balance is. Doing so could save you money if you can get an interest rate significantly lower than your current mortgage rate, but this strategy also carries significant risks. HELOCs are variable rate products, which means your interest rate and monthly payment could change unexpectedly at any time, a likely possibility given the current environment of rising rates.
Here’s how using a HELOC to pay off your mortgage can work, and the main drawbacks and considerations experts say you should be aware of before you get started.
Can you use a HELOC to pay your mortgage?
Let’s start with the basics: A home equity line of credit, or HELOC, is a revolving line of credit that acts as a “second mortgage” on your home and allows you to borrow against the home equity. It works like a credit card: you can spend as much or as little balance as you like during the withdrawal period, up to a certain limit, and then pay only for what you use.
It can be an attractive option for many different reasons, namely flexibility and low or no closing costs, and many borrowers are using them these days to finance home renovations.
Using a HELOC to pay off your mortgage is less conventional, but it can be done, says Locke.
Here’s how it would work: Let’s say you have a 30-year mortgage with a principal balance of $300,000 and an interest rate of 6 percent. After 27 years of payments, your remaining mortgage balance is now $58,149, according to NextAdvisor’s loan amortization calculator. If your home is now worth $500,000, that means you have a little over $440,000 in equity to work with.
You could take $58,149 out of a HELOC with a lower interest rate (for example, 3 percent) and use it to pay off your mortgage. You would then pay the HELOC as normal, allowing you to save on interest.
However, there are some limits to this strategy. Banks are generally only willing to lend up to 80 percent of the value of your home. In other words, your mortgage balance plus your HELOC balance can only add up to 80 percent of your home’s total value, leaving 20 percent of the equity untouched. Your remaining mortgage balance must also be less than your HELOC line of credit if you want to use a HELOC to pay off your mortgage in full.
Advantages of using a HELOC to pay your mortgage
Depending on your situation, there may be some benefits to using this strategy.
- Low or no closing costs. Banks will often offer HELOCs without charging you many up-front fees. That makes it a more attractive option than a traditional refinance of your primary mortgage, which could cost thousands of dollars up front.
- Flexibility. Because a HELOC works like a credit card, it can give you more options for how you use the money over time. You can use the HELOC to pay off your mortgage and then use some of the money for home renovations. It gives you “the flexibility to finance future home projects without incurring more closing costs down the line,” says Locke.
- Lower interest rates: If your primary mortgage is old, it may have a much higher interest rate than what is currently being offered. In the example above (a 30-year mortgage at 6% interest with 3 years and $58,149 remaining), using a $58,149 HELOC at 3% interest and paying it off over 3 years could save you about $2,700 in interest, according to Calculator NextAdvisor Loans. But this only works if your HELOC interest rate does not increase during those 3 years.
Disadvantages of using a HELOC to pay your mortgage
There are some significant risks to using a HELOC to pay your mortgage that you should also be aware of.
- Variable interest rates: “Home equity lines are variable interest rates, meaning the interest rate can change over time. Interest rates are going up, not down,” says Nadine Marie Burns, certified financial planner and CEO of A New Path Financial. That means that even if your initial HELOC interest rate is lower than the fixed rate on your primary mortgage right now, you could easily beat it in the future. The Federal Reserve is expected to raise interest rates at least six times this year alone.
- Lack of discipline: The fact that a HELOC works like a credit card is a huge draw for many, but it can also be a significant risk. “It’s an open line of credit like a credit card, so it can be very dangerous for people if they don’t have a good sense of money,” says Locke. In other words, if you need the discipline of a fixed monthly mortgage payment, a HELOC may not be right for you.
- Increase your debt load: At the end of the day, a HELOC is a second mortgage. Even if you intend to use it to pay off your primary mortgage, you’re still taking out another loan and possibly adding to your short-term debt, which is a risky move.
Is it a good idea for me to use a HELOC to pay my mortgage?
Using a HELOC to pay your mortgage is a decision that depends a lot on your personal situation, but you should also be informed by what is happening in the financial market. The most important factor in today’s market, experts say, is the upward trend in interest rates.
“Right now, those downsides are really strong because typically home equity loans have variable interest rates. We are in an environment where interest rates are rising rapidly,” says Locke.
That means the main potential benefit of using a HELOC to pay off your mortgage — a lower interest rate — will likely wear off quickly, leaving you with an unpredictable monthly payment.
“Why would you trade a low-cost fixed rate on your regular mortgage for a variable rate that could go up?” Burns points out. Especially if you got your mortgage in recent years, when rates have been historically low, it’s unlikely that trading it for a HELOC will benefit you.
Instead of rushing to pay off your mortgage, which Burns says is usually “good debt,” he recommends focusing on other debt first.
“Get rid of the credit card [debt] first get rid of student loans, get rid of car payments,” says Burns.
Paying off your mortgage early is not always the best idea. There may be more productive uses for your money.
Your debt strategy also depends on your age, says Burns. In your 20s, 30s, or 40s, there’s nothing wrong with having a mortgage payment. These are the years when you should focus on paying off the aforementioned “bad debts” and saving for retirement, he explains.
It’s not until you’re much closer to retirement that you should start thinking about how to eliminate your mortgage payment.
“At age 50, if you still have to pay for the house, that’s when you need to be really aggressive,” says Burns.
Alternatives to paying my mortgage
If you follow Burns’ advice and eliminate other forms of debt, you may have an extra few hundred dollars each month for your mortgage. Here are some strategies to pay off your mortgage sooner without resorting to a HELOC:
- Make biweekly payments: Splitting your monthly mortgage payments in half and paying every two weeks is a common trick to pay off your mortgage faster. It results in 26 payments per year, adding up to a full extra monthly payment without you even realizing it.
- Make extra payments: If you want to keep paying monthly, you can also get by by simply making an extra payment or two whenever you can. It may seem small, but adding extra payments can cut a significant amount of interest and time off your loan.
- Reformulate your mortgage: This option makes sense if you have a large amount of money that you want to put toward your mortgage at one time. You would work with your lender to pay off that portion of your mortgage, and then “refund” the remaining balance with an adjusted amortization schedule and lower monthly payment.
All that said, you may not want to pay off your mortgage early. As Burns says, it’s not always necessary, especially if you’re younger. Locke also says that might not be a good move, especially if your interest rate is low, because the extra money could be better used in an investment account, for example.