If you’re like many homeowners, you’re probably sitting on a lot of your home’s equity right now and wondering if you can put it to good use.
“People have a lot more equity than they have [had] in the past,” says Matthew Locke, National Head of Mortgage Sales at UMB Bank. Home value growth in 2021 – spurred by soaring home prices in a competitive housing market – exceeded median wages in 25 of the 38 major metropolises, according to the real estate market Zillow.
Home improvement financing and debt consolidation are two proven uses for your home equity, but what if you want to use it to pay off your main 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 much money you have left on your mortgage. It could save you money if you’re able to get an interest rate that’s significantly lower than your current mortgage rate, but there are significant risks associated with this strategy as well. HELOCs are variable rate products, which means that your interest rate and monthly payment can change unexpectedly at any time – a likely possibility given the current rate hike.
Here’s how using a HELOC to pay off your mortgage can work, and the top downsides and considerations experts say you should know before you get started.
Can you use a HELOC to pay off 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 lets you borrow against the equity in your home. It works a bit like a credit card: you can spend the balance as much or as little as you want during the draw period, up to a certain limit, and then only pay back what you use.
This 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, Locke says.
Here’s how it would work: Let’s say you had a 30-year mortgage with a principal balance of $300,000 and an interest rate of 6%. After 27 years of payments, the remaining balance on your mortgage is now $58,149, according to NextAdvisor’s Loan Amortization Calculator. If your home is now worth $500,000, that means you have just over $440,000 in capital to work with.
You can withdraw $58,149 from a HELOC with a lower interest rate — say, 3% — and use it to pay off the mortgage. Then you’ll pay off the HELOC as usual, saving you on interest.
However, there are some limitations to this strategy. Banks are generally only willing to lend up to 80% of the value of your home. In other words, your mortgage balance plus your HELOC balance can only add 80% of your home’s total value, leaving 20% of 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.
Benefits of using a HELOC to pay off your mortgage
Depending on your situation, there may be some advantages to using this strategy.
- Low or no closing costs. Often, banks offer HELOCs without charging you a lot of upfront fees. This makes it a more attractive option than a traditional refinance of your main mortgage, which could potentially cost thousands of dollars upfront.
- Flexibility. Because a HELOC works like a credit card, it can give you more options for using the money over time. You can tap into the HELOC to pay off your mortgage, then later use some of the money for home improvements. This gives you “the flexibility to finance future home projects without having to incur more closing costs later,” says Locke.
- Lower interest rates: If your main mortgage is old, you may have a much higher interest rate than is currently available. In the example we gave above (a 30-year mortgage at 6% interest with 3 years and $58,149 remaining), using a HELOC for $58,149 at 3% interest and paying it off on 3 years could save you around $2,700 in interest, according to NextAdvisor’s Loan Calculator. But that only works if your HELOC interest rate does not increase during those 3 years.
Disadvantages of using a HELOC to pay off your mortgage
Using a HELOC to pay off your mortgage carries some significant risks that you should also be aware of.
- Variable interest rates: “Home equity margins are variable interest rates, which means 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. This means that even if your initial HELOC interest rate is lower than the fixed rate on your main mortgage right now, it could easily exceed 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 big draw for many, but it can also be a big risk. “It’s an open-ended 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,” Locke says. In other words: if you need the discipline of a fixed monthly mortgage payment, a HELOC might not be right for you.
- Increase in your debt: Ultimately, a HELOC is a second mortgage. Even though your intention is to use it to pay off your main mortgage, you’re still taking out another loan and potentially increasing your short-term debt, which is a risky move.
Is it a good idea for me to use a HELOC to pay my mortgage
Whether or not to use a HELOC to pay off your mortgage is a decision that very much depends on your personal circumstances, but it should also be informed by what is happening in the financial market. According to experts, the main driver of the current market is the upward trend in interest rates.
“Right now, those downsides are really big because home equity loans are usually variable interest rates. We are in an environment of rapidly rising interest rates,” Locke says.
This means that the main potential benefit of using a HELOC to pay off your mortgage – a lower interest rate – will likely disappear quickly and leave 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 took out your mortgage in the past few years – when rates have been historically low – you’re unlikely to be able to swap it out for a HELOC.
Instead of rushing to pay off your mortgage — which Burns says is generally “good debt” — she recommends focusing on other debts first.
« Get rid of the credit card [debt] first, get rid of student loans, get rid of car payments,” Burns says.
Paying off your mortgage early isn’t always the best idea. There may be more productive uses for your money.
Your debt strategy also depends on your age, Burns says. In your twenties, thirties or forties, there is nothing wrong with having a mortgage payment. These are the years when you should focus on paying off the aforementioned “bad debt” and saving for retirement, she explains.
It’s only when you’re getting a lot closer to retirement that you should start thinking about how to eliminate your mortgage payment.
“In your 50s, if you still have a house payment, that’s when you have to get really aggressive,” Burns says.
Alternatives to paying off my mortgage
If you follow Burns’ advice and eliminate other forms of debt, you could have a few hundred extra dollars each month to spend on your mortgage. Here are some strategies for paying off your mortgage sooner without resorting to a HELOC:
- Make payments every two weeks: Splitting your monthly mortgage payments in half and paying every two weeks is a common trick to paying off your mortgage faster. This results in 26 payments per year, which is a full extra monthly payment without you even realizing it.
- Make additional payments: If you want to keep paying monthly, you can also get ahead by just making an extra payment or two whenever you can. It may seem small, but adding extra payments can significantly reduce the interest and term of your loan.
- Overhaul of your mortgage: This option makes sense if you have a large sum of money that you want to spend on your mortgage all at once. You would work with your lender to pay off that portion of your mortgage, then “recombine” the remaining balance with an adjusted amortization schedule and lower monthly payment.
That said, you might not want to pay off your mortgage early at all. As Burns says, it’s not always necessary, especially if you’re younger. Locke also says it might not be a good move, especially if your interest rate is low, because the extra money could be better spent in an investment account, for example.