A home equity line of credit, more commonly known as a HELOC, works a bit like a credit card. You get approved to borrow a certain amount and you can draw from that amount throughout a pre-determined draw period, usually about 10 to 15 years.
The advantage of a HELOC is that you can often borrow much more than you could with a credit card, and you can do so at a lower interest rate. The current average interest rate on credit cards is around 17 percent, while HELOC rates tend to hover just over 5.5 percent.
While a HELOC can offer tax benefits(1), there are limitations: You must be putting your HELOC towards buying, building, or significantly improving your home to qualify for deductions. These possible tax advantages are why many homeowners choose a HELOC, not only to pay off a mortgage, but also to make home improvements.
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How to Use Your HELOC to Pay Off Your Mortgage
If you’re planning on using a HELOC to pay off your mortgage, you first need to make sure that the amount you have available to borrow is equal to or greater than what you owe.
HELOC lenders will usually lend up to 80 percent of your home’s value, minus the amount that you owe on your mortgage. For example, if you have a $250,000 loan with a $100,000 balance, 80 percent of your home’s value would be $200,000. Subtract the balance on your mortgage and you have $100,000 available to borrow.
HELOCs usually have variable interest rates.
In this situation, you’d take the full $100,000 as soon as you were approved and send that money to your mortgage lender. You might choose to start repaying interest plus principal on your HELOC or continue to pay interest only until the loan enters its repayment period. Interest on a HELOC is usually variable, although you may be able to lock-in your interest rate–allowing you to borrow from your HELOC at a fixed interest rate.
Pros of Using a HELOC to Pay Off Your Mortgage
If you qualify for a good interest rate and choose the right option for your needs, using your HELOC to pay off a mortgage can be a savvy financial decision.
1. You can end up paying less
The longer you carry a mortgage balance, the more interest you accrue. You still pay interest on a HELOC, of course, but you could score a significantly lower interest rate, especially if you took out a fixed-rate mortgage when market rates were high.
If that happens, then you’ll accrue less interest with the HELOC than you would with your original mortgage. Less interest accrued means a lower overall cost of the property.
2. You can do other things with the money, too
If you have more available to borrow than you’d need to pay off your mortgage, you can choose not to borrow the remaining amount, or you could do something else with it.
Remember, you may be able to deduct HELOC interest from your taxes if you use the money to buy or improve your home.
How great would it be to pay off your mortgage and update your kitchen and bathroom? If your renovation increases the value of your home, you’ll build your equity faster than if you were just paying off the loan.
Cons of Using a HELOC to Pay Off Your Mortgage
No loan product is perfect for everyone or every situation. Consider these factors before you commit to a HELOC.
1. You still have to pay off the same principal amount
If you borrow $100,000 against your equity using a HELOC and use it to pay off your mortgage, you’ll still have to pay off your HELOC.
2. You could lose your home if you default.
Your home serves as collateral on a HELOC. If you fall behind on payments, your lender can foreclose, just as your original mortgage lender could.
Using a HELOC to pay off a mortgage is simple. Assuming you can get approval and have enough in equity, you simply borrow the balance of your mortgage and send it to the lender.
The process is best suited for a homeowner who:
- Has more equity than debt in a property
- Can get a lower rate on a HELOC than they have on their mortgage,
- Or has enough equity to also make some improvements on the home.
Interested? Learn more about the process of taking out a HELOC and determine whether it’s the right choice for your home and your finances.
(1) Prosper does not provide tax advice. Please consult a tax advisor regarding the potential deductibility of interest and charges.