Can You Use a HELOC to Pay Off Your Mortgage?
To be absolutely technical, you can indeed use a HELOC, or home equity line of credit, in order to pay off your mortgage. With that said, there are better ways to pay off a mortgage than with a HELOC. In order to get a glimpse of the full HELOC to pay off mortgage picture, we’ll need to go into some detail. Keep reading in order to hear about the particulars.
The Differences between a HELOC and a Mortgage
These two things do have some similarities. They are both loans that are taken out against a house. You need to go to a bank or a lender and meet with a loan officer in order to obtain one. Over time, both must be paid back, and whether or not you qualify depends on your credit score and debt to income ratio. However, the similarities end there.
The differences are what really matter. Let’s break it down:
• A mortgage is usually a fixed rate loan. A HELOC is not.
• A HELOC can be easily frozen by the bank because it is a line of credit. Once you have a mortgage, it cannot be taken away.
• Usually, a HELOC is paid off over a ten to 20-year period. A mortgage is typically 30 years.
• During the initial draft period, you just need to pay the interest on a HELOC, not the principle. A mortgage is similar in that the first few years of payment consist of mostly interest and not a lot of the principle, but towards the end of the loan period, the opposite is true.
How Would This Work?
In the HELOC to pay off mortgage scenario, you would need to have enough equity in your home in order to take out the HELOC in the first place. Let’s use an example – if you have a home that’s worth $200,000 and only owe $75,000 on your mortgage, then you would be able to take out a $75,000 HELOC and use it to pay off your mortgage. That just leads to swapping one loan for another. If your equity is lower and your mortgage higher, then this wouldn’t work at all.
Why would you want to take out a HELOC and pay off your mortgage? Well, if the interest rate on your mortgage is extremely high, then you’d benefit from a HELOC, where the rate is tied to the federal interest rate. However, when that rate goes up, the amount of interest that you’re paying would as well. On top of this, the interest on a HELOC compounds – it isn’t a flat rate like it is with a mortgage loan. This means that you could end up paying more in interest in the long run.
Paying Off a Mortgage
The best scenario involves getting a HELOC and using it for emergency expenses, home remodels, and paying off other high-interest debt while still having your original mortgage. Then, you could focus on paying off your mortgage in one of the many recommended ways, including:
Making additional principal payments on it. Many lenders won’t penalize you for this. If you can afford it, pay an extra amount each month, and make it clear that this amount is for the principal on the loan. Look at it this way – if you pay an additional $100 each month towards the principal, then you’re knocking $1,200 off of your loan each year. This adds up very quickly.
Choose to refinance your loan. Refinancing your loan is a good way of getting a better interest rate, especially if you only qualified for a very high rate when you first took out the mortgage. If you know that your debt to income ratio has gone down and your credit rating has gone up, then this is a good way of obtaining a less expensive mortgage.
Pay double payments a few times a year. Another good method of getting rid of a mortgage quickly is by paying double. Even if you can only do this twice a year, it will help you knock down your overall principal. You’ll be that much closer to paying off the loan that way.
Use Your HELOC for Other Purposes
Even though it isn’t always wise to use a HELOC in order to pay off your mortgage, there are plenty of other uses for them. We mentioned some of them here, including home remodels, credit card payoffs, and getting rid of other debt. In addition, some people prefer to use a HELOC as a general safety net. If the money in an emergency situation, then they have it available right there. Since all that they need to pay off during the draft period is the interest, this makes them a useful funding source to have on hand.