How to Use a HELOC to Pay Off Your Mortgage

How to Use a HELOC to Pay Off a Mortgage

Wiping out your mortgage with a HELOC is a pretty straightforward process. Follow these steps to make it happen.

1. Check Your Qualifications

Before you start, it's a good idea to see if you meet the eligibility criteria for a HELOC. Requirements vary by lender, but you'll generally need the following:

• Good credit: While you may qualify for a HELOC with a credit score as low as 680, a higher score may improve your odds of qualifying and receiving favorable terms.
• Sufficient equity: You must have equity in your home. Most lenders will require at least 20% home equity for a HELOC.
• Low debt-to-income ratio (DTI): Your total monthly debt obligations should represent no more than 43% of your gross monthly income, but the lower, the better.
• Adequate and consistent income: Lenders want to verify that your income is reliable and high enough to cover a new HELOC payment. Be prepared to provide your lender with supporting documents like recent pay stubs, W-2s and federal tax returns.

2. Determine Your Borrowing Limit

Next, you'll want to determine how much you can borrow with a HELOC to make sure it's enough to pay off your primary mortgage. The amount you're eligible to borrow largely depends on how much equity you have in your home and the lender's maximum limit.

While some lenders have higher maximums, you can typically borrow up to 80% of your combined loan-to-value ratio (CLTV), meaning the total amount of your current mortgage loan and your HELOC can't be more than 80% of your home's value.

Example: Say you have 10 years left on a 30-year mortgage for $250,000 with a 6% interest rate. Your mortgage balance is $135,009 and your home's value is currently $400,000, leaving you with $264,991 in equity. In this case, you could borrow roughly half of your equity, 50.09% to be exact, to pay off your home loan.

3. Shop and Compare Lenders

It's wise to compare multiple HELOC offers from banks, credit unions and online lenders. Prequalifying with lenders can help you see what amounts, rates and terms you may qualify for, without impacting your credit.

Don't forget to compare fees, especially prepayment penalties. Not all lenders charge one for paying off your HELOC early, but if that's your plan, make sure you ask about it and know what it could cost you.

Learn more: How Does a HELOC Affect Your Credit Score?

4. Apply for a HELOC

Once you've figured out how much you need to borrow and compared your options, the next step is to choose a lender and fill out a formal application. Be ready to respond to your lender's requests for supporting documents that verify your identity, income and assets. Submitting them promptly can help avoid delays in processing.

Be prepared to submit:

• Proof of income: You may need your two most recent W-2s, recent pay stubs or tax returns.
• The estimated value of your home: Your lender may order an appraisal to assess your home's value.
• Your current mortgage balance and monthly payment from your mortgage statement: This information helps your lender calculate your CLTV.
• Bank and investment account statements: Your lender will want to know how much you have in savings and other assets.

5. Close on Your HELOC

If your lender approves your application, you'll close on your HELOC much like you did with your original mortgage. But instead of getting a lump sum, you'll have access to a revolving line of credit, similar to a credit card. You can draw as needed and repay it at a variable interest rate.

Your funds will become available once your loan closes and your right of rescission period ends. This is a three-day cooling-off period during which you can cancel the HELOC for any reason without penalty.

Learn more: How Much Are Home Equity Loan or HELOC Closing Costs?

6. Use the HELOC to Pay Off Your Primary Mortgage

After the right of rescission period, you can draw from your credit line to repay the mortgage. Keep in mind, HELOCs have two periods:

• Draw period: You can only draw funds during the HELOC's initial draw period, typically from three to 10 years. During this time, you can borrow as needed up to your credit limit and make interest-only payments on the amount withdrawn.
• Repayment period: Once the draw period ends, the credit line closes and you can no longer withdraw funds. At that point, you'll make full payments, including the principal and interest, for the rest of the term, which is usually another 20 years.

Your lender may provide access to the funds through a direct deposit, checks or a credit card tied to the account. Once the funds are available, you can use them to repay your primary mortgage.

Learn more: How Does HELOC Repayment Work?

Pros and Cons of Using a HELOC to Pay Off Your Mortgage

While a HELOC can help eliminate your primary mortgage and offer other benefits, it also carries risks you should weigh carefully beforehand.

Should You Use a HELOC to Pay Off Your Mortgage?

Paying off your mortgage can make sense in some situations, but not always. Here's when this strategy might make sense for you and when it probably doesn't.

When Using a HELOC Might Be a Good Idea

• You can save money on interest. If you can secure a HELOC interest rate that's lower than your current mortgage rate, you might pay less than you would over your original mortgage term.
• You want to reduce your monthly payments. A HELOC can help you get rid of your primary mortgage payment, and the interest-only payments during the initial draw period may be lower than what you were paying on your mortgage.
• You also want access to extra funds. Depending on your mortgage payoff amount and your HELOC borrowing limit, you may be able to pay off your mortgage and still have access to funds for other needs or opportunities.

When Using a HELOC Might Not Be a Good Idea

• When HELOC rates are higher. If you took out your primary mortgage before 2022, there's a good chance your mortgage rate is substantially lower than current market HELOC rates. In that case, switching to a HELOC could actually cost you more in interest over time.
• You're switching from a fixed rate to a variable one. Most HELOCs have variable interest rates, which can rise over time and make your payments unpredictable. If your current mortgage has a fixed rate, moving to a HELOC could expose you to more risk.
• You're close to paying off your mortgage. In most cases, it doesn't make sense to replace a loan with just a few years left with a HELOC that could extend repayment up to 30 years.

Alternative Ways to Pay Off a Mortgage

If you don't want to pay off your mortgage with a HELOC, you still have the following alternative options worth exploring.

Paying Extra

Making extra loan payments is an excellent way to pay off your mortgage significantly faster. On a 30-year fixed-rate mortgage, for instance, making one extra payment each year could reduce your payoff time by several years, depending on your loan terms and interest rate. If you're near the end of your loan term, the impact of extra payments is diminished because most of the interest has already been paid. Run your numbers through an amortization extra payment calculator to determine how much sooner you might pay off your mortgage with additional loan payments.

One easy way to make an extra annual payment is to pay your mortgage biweekly. With this strategy, you'll make 13 payments a year instead of 12, which helps accelerate your payoff timeline. Just make sure to check with your lender so the extra funds go toward your principal, not the interest.

Home Equity Loan

A home equity loan works similarly to a HELOC in that it lets you borrow against the equity in your home, but the structure is different. Instead of a revolving credit line, you receive a lump sum upfront and repay it in fixed monthly installments at a fixed interest rate.

You could use proceeds from the lump sum to pay off your mortgage. You may prefer this option if you want fixed payments, but you'll need to compare interest rates, terms and fees to determine if it's worth it.

Refinance

If you can score a lower interest rate on a shorter-term loan compared to your primary mortgage, refinancing might make sense as a way to pay off your loan early and save money on interest charges.

For example, if you have 20 years left on a 30-year fixed-rate mortgage, switching to a 15-year term could pay off your mortgage five years sooner. Just make sure you can handle the larger monthly payment before refinancing.

Reverse Mortgage

A reverse mortgage may be an option worth exploring if you're 62 or older. This option allows you to convert some of your home equity into cash so you can pay off your existing mortgage. Many homeowners opt for a reverse mortgage when they want to get rid of their monthly mortgage payment to reduce strain on their budget in retirement.

What's unique about a reverse mortgage is that you don't have to make monthly payments on it because repayment is delayed until you sell the home, move out, pass away or fail to meet certain loan terms. As with any loan, weigh the pros and cons of a reverse mortgage before proceeding.

Improving Your Credit Could Result in Lower HELOC Rate

Whether or not you should use a HELOC to pay off a mortgage depends on your unique circumstances and your financial goals. It could make sense if you have a low mortgage balance, substantial equity and you can qualify for a lower interest rate than your current mortgage. On the other hand, if HELOC rates are higher or your mortgage is almost paid off, the costs and downsides may outweigh the benefits.

A good credit score may help you qualify for a lower interest rate on a HELOC. If your FICO^® Score^☉ is low, consider taking steps to improve your credit score before you apply. Begin by checking your FICO^® Score and credit report for free with Experian.