How to use a HELOC to pay off your mortgage

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A home equity loan or HELOC can be an option to pay off your mortgage or even zero it out. Here’s how the strategy works. (Shutterstock)

A home equity loan and a home equity line of credit (HELOC) are valuable tools that can help you tap into the equity in your home for cash. You can use a home equity loan or HELOC to pay for any major expense, such as a home improvement project.

In some situations, these home equity financing options can lower your monthly mortgage payments or even allow you to pay off your mortgage ahead of schedule. Before you start the process, make sure you understand how to use a mortgage and HELOC to pay off your mortgage and if you’ll save money in the long run.

Credible, it’s easy to get a HELOC through lending partners.

How HELOCs Work

Unlike home equity loans, which give you a lump sum of money, HELOCs give you access to a line of credit. In this way, HELOCs work like a credit card, allowing you to withdraw money as needed up to your maximum limit.

Generally, you cannot borrow more than 85% of your combined loan-to-value ratio (CLTV). The CLTV measures the amount of your current mortgage balance plus the amount you want to borrow compared to the value of your property.

HELOCs typically come with variable interest rates and two terms:

  • Draw period — During this period, which is usually 10 years, you can access your line of credit as needed up to your limit and only pay interest on the amount you borrow.
  • Repayment period — This period, which lasts from 10 to 20 years, begins when the drawdown period expires. You can no longer access the funds during this period and must make monthly payments including principal and interest.

How to use a HELOC to pay off your mortgage

Taking out a HELOC to pay off or eliminate your original mortgage is an option, but it’s not something everyone should consider. You could save money if you have substantial equity and can get a lower interest rate, but often the devil is in the details. Consider this example:

Say your home is worth $500,000 and your remaining mortgage balance is $100,000. You took out the mortgage 25 years ago with an interest rate of 6% and monthly payments of $2,398.20. If you keep on pay off your house over the next five years, you will pay $19,843 in total interest costs over that period.

But what if you qualify for a $100,000 HELOC with no closing costs, a variable interest rate of 3.99%, a draw period of five years and a repayment term of 15? year ? Here you have two options for paying off your original mortgage with a HELOC.

Redeem the HELOC during the draw period

With this option, you could still pay off your home in five years, make lower monthly payments and save on interest. Your monthly principal plus interest payments would be $1,841.20, about $557 less than what you were making on your original mortgage. Plus, you’ll pay $10,427 in interest on your HELOC, which is $9,416 less than what you would have paid with your original mortgage.

Remember, however, that HELOCs are variable rate products, which means that your APR and monthly payments could increase with any increase in interest rates. Some lenders now offer Fixed Rate HELOCwhich might be a better option.

Also, keep in mind that some lenders charge prepayment penalty fees, so make sure you understand the terms of any HELOC you’re considering before adopting this strategy.

Pay the minimum during the draw period

If your income is lower than it was in the past, you can choose to make only minimum interest payments during the draw period. Using the example above, your minimum payment rises to $332 before climbing to $739 over the 15-year repayment period.

In this case, you create a significant space in your budget, reducing your monthly payment by approximately $2,066 during the draw period and $1,659 during your repayment period. Of course, the catch is that you’re paying interest over a much longer period – 15 more years to be exact – and you’ll be paying over $53,000 in total interest.

Again, these numbers do not take into account any rate increases that might accompany a variable rate HELOC. With this option, you’ll pay more interest than you would on your original mortgage, but it could free up space in your budget.

Should you use a HELOC to pay off your mortgage?

Deciding whether or not to get a HELOC to pay off your mortgage will depend on your unique financial situation. If you have a low balance remaining on your mortgage and can get a lower interest rate, this option may make financial sense.

On the other hand, if you don’t have a lot of equity and already have a low interest rate, you may not be able to get a HELOC with a low enough APR to make it worthwhile. .

Also, a variable rate HELOC is generally not a good option if your income is uneven or irregular. A drop in income when interest rates rise can make it harder to budget for your monthly payments. If you can’t make your payments, you risk losing your home since your home secures your HELOC.

Other things to consider are the upfront costs and annual fees that often come with a HELOC, including:

  • Expert fees
  • Application fees
  • Closing costs
  • Annual fees
  • Inactivity fees
  • Prepayment charges

How to Get a Home Equity Loan

A home equity loan may be a better option if you don’t need access to cash for an extended period of time. Home equity loans offer a one-time lump sum payment, which could be all you need to pay for a new roof, install a swimming pool, or finance any other major home improvement. Follow these steps to find a home equity loan that meets your needs:

  1. Determine the amount you want to borrow. Understanding how much money you need to reach your goal will help you when shopping around and comparing loan offers.
  2. Calculate the equity in your home. You will need at least 15% to 20% equity to qualify for a home equity loan. To determine how much equity you have, subtract your current mortgage balance from the market value of your home.
  3. Shop around and compare rates from multiple lenders. Interest rates and repayment terms vary by lender, so it pays to compare several loan offers to find the right one. Best rate and conditions for you.
  4. Submit your application. Once you’ve chosen a lender, you’ll need to complete an application and provide all requested documents, such as recent pay stubs, bank statements, and employment verification.
  5. Sign for your loan. Once your loan has been processed, you can pay closing costs and open your new loan account.

How to get a HELOC

If you have at least 15% equity in your home, you may qualify for a HELOC, and lenders will consider your credit, debt-to-equity ratio, and other factors. Here are the steps to take to get a home loan:

  1. Shop around and compare lenders. It’s wise to shop around with multiple lenders to ensure you get the best deal. Compare loans, interest rates, and terms to find the best HELOC that fits your needs.
  2. Gather supporting documents. Before applying, gather your government-issued ID, bank and investment account statements, pay stubs, W-2 forms, and other documents confirming your citizenship status, income, and citizenship. use.
  3. Complete the application. Fortunately, you can usually complete a home loan application quickly and easily online. After you submit your application, your loan officer may ask you to send additional documents or schedule a property appraisal.
  4. Close your loan. On your closing date, you will sign documents, pay closing costs and activate your HELOC. It can take two to six weeks to process and close your loan.

Which is better: home equity loan or HELOC?

Decide between a home equity loan and a HELOC can come down to when you need money. A home equity loan may be best for you if you need a large amount to cover a large one-time expense, such as an unexpected medical bill.

On the other hand, a home equity line of credit might be better if you don’t need all the money right away, because you only pay interest on the amount you borrow.

Before you decide, crunch the numbers and compare the interest rates, fees and terms of your current loan versus a home equity product.

If you’re ready to apply for a home loan, Credible makes it quick and easy compare mortgage rates to find the right one for your unique situation.

Amanda P. Whitten