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 a lot more equity than they have [had] in the past,” says Matthew Locke, national mortgage sales manager at UMB Bank. Home value growth in 2021 — spurred by soaring home prices amid a competitive housing market — exceeded median salaries in 25 of 38 major metros, according to real estate marketplace Zillow.
Funding home renovations and consolidating debt are two tried-and-true uses for your home equity, but what if you want to use it to pay off your primary mortgage?
Using a home equity line of credit (HELOC) to pay off your mortgage is possible, but it depends on how much equity you have and how large the remaining balance on your mortgage is. Doing so could save you money if you’re able to get a significantly lower interest rate than your current mortgage rate, but this strategy also carries significant risks. HELOCs are variable rate products, meaning your interest rate and monthly payment could unexpectedly change at any time — a likely possibility given the current rising rate environment.
Here’s how using a HELOC to pay off your mortgage can work, and the key drawbacks and considerations experts say you should be aware of before you jump in.
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 house and allows you to borrow against your home equity. It works something 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 pay back only what you use.
It can be an attractive option for many different reasons — namely flexibility and low or no closing costs — and a lot of borrowers are using them these days to fund home renovations.
Using a HELOC to pay off your mortgage is more unconventional, 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 percent. After 27 years of payments, the remaining balance on your mortgage is now $58,149, according to NextAdvisor’s loan amortization calculator. If your house is now worth $500,000, that means you have a little more than $440,000 in equity to work with.
You could take out $58,149 from a HELOC with a lower interest rate — for example, 3 percent — and use it to pay off the mortgage. Then you’d pay off the HELOC as normal, allowing you to save on interest.
There are some limits to this strategy, though. Banks are usually only willing to lend up to 80 percent of the value of your home. In other words, the balance of your mortgage plus the balance of your HELOC can only add up to 80 percent of your total home value — leaving 20 percent of the equity intact. Your remaining mortgage balance must also be smaller than your HELOC credit line if you want to use a HELOC to pay off your mortgage in full.
Advantages to Using a HELOC to Pay Off Your Mortgage
Depending on your situation, there can be some benefits to using this strategy.
- Low or no closing costs. Often, banks will offer HELOCs without charging you lots of upfront fees. That makes it a more attractive option than a traditional refinance of your primary mortgage, which could potentially cost thousands of dollars upfront.
- flexibility. Because a HELOC functions like a credit card, it can give you more options for how to use the money over time. You might draw on the HELOC to pay off your mortgage, and then later use some of the money for home renovations. It gives you “the flexibility to fund future house projects without having to incur more closing costs down the road,” Locke says.
- Lower interest rates: If your primary mortgage is old, it’s possible you have a much higher interest rate than what’s being offered right now. 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 over 3 years could save you around $2,700 in interest, according to NextAdvisor’s loan calculator. But this only works if your HELOC interest rate doesn’t rise during those 3 years.
Disadvantages to Using a HELOC to Pay Off Your Mortgage
There are some significant risks to using a HELOC to pay off your mortgage that you should also be aware of.
- Variable interest rates: “Home equity lines are variable interest rates, which means the interest rate can change over time. Interest rates are going up, not down,” says Nadine Marie Burns, a 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, it could easily rise above 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 functions like a credit card is a big draw for many, but it can also be a significant 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 money sense,” Locke says. In other words: If you need the discipline of a fixed monthly mortgage payment, a HELOC might not be right for you.
- Increasing your debt load: At the end of the day, a HELOC is a second mortgage. Even if your intent is to use it to pay off your primary mortgage, you’re still taking out another loan and potentially increasing your debt in the short term, which is a risky move.
Is It a Good Idea for Me to Use a HELOC to Pay My Mortgage
Whether to use a HELOC to pay off your mortgage is a decision that depends a lot on your personal situation, but it should also be informed by what’s going on in the financial market. The biggest factor in today’s market, experts say, is the trend of rising interest rates.
“Right now, those disadvantages are really strong, because typically home equity loans are variable interest rates. We’re in an environment where interest rates are rapidly increasing,” Locke says.
That means that the main potential benefit of using a HELOC to pay off your mortgage — a lower interest rate — will probably 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 last few years — when rates have been historically low — trading it for a HELOC is unlikely to benefit you.
Instead of rushing to pay off your mortgage — which Burns said is usually “good debt” — she recommends focusing on other debts first.
“Get rid of credit card [debt] first, get rid of student loans, get rid of car payments,” Burns says.
Per tip
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 20s, 30s, or 40s, there’s nothing wrong with having a mortgage payment. These are the years you should be focused on paying off the aforementioned “bad debts” and saving for retirement, she explains.
It’s not until you get much 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 need to get really aggressive,” Burns says.
Alternatives to Paying Off My Mortgage
If you take Burns’ advice and eliminate other forms of debt, you might have a few hundred extra dollars every month to put towards your mortgage. Here are some strategies for paying 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 one common trick to paying off your mortgage faster. It results in 26 payments per year, adding up to a full extra monthly payment without you even noticing.
- Make extra payments: If you want to keep paying monthly, you can also get ahead by simply making an extra payment or two whenever you can. It might seem small, but adding in extra payments can shave a significant amount of interest and time off your loan.
- Recast your mortgage: This option makes sense if you have a large chunk of money that you want to put toward your mortgage all at once. You would work with your lender to pay off that chunk of your mortgage and then “recast” the remaining balance with an adjusted amortization schedule and lower monthly payment.
All of that said, you may not want to pay your mortgage off early at all. As Burns says, it isn’t 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 put to better use in an investment account, for example.
