Can you use a HELOC to pay off your mortgage?
Quick insights
- Using a home equity line of credit (HELOC) to pay off the mortgage of your primary residence may help you save money on interest, make lower monthly payments and manage cash flow to pursue other financial priorities.
- HELOCs may include certain fees, a variable rate structure and potential tax disadvantages when compared to a traditional mortgage.
- To be approved for a HELOC, you must meet lender-specific eligibility criteria and provide documents related to your mortgage, employment, credit history and other debts.
A home equity line of credit (HELOC) allows you to leverage your home’s equity for major expenses, which can include repaying your mortgage. In this article, we’ll explain how this lending option works and the pros and cons of using a HELOC to pay off the mortgage for your primary residence.
Overview of HELOCs
A HELOC is a revolving line of credit that allows you to borrow against your home’s equity. You may withdraw funds up to your approved limit either all at once or as needed during the ‘draw’ period, which typically lasts between 3 and 10 years, depending on the lender.
During the draw period, borrowers may have the option to make interest-only payments, which can help keep monthly costs in check or enable you to pursue other financial opportunities. Once the draw period is over, payments must be made to both the interest and principal, and no more money can be withdrawn using the HELOC.
Pros and cons of using a HELOC to pay off a mortgage
Whether paying off your mortgage early with a HELOC is a good idea may depend on your personal circumstances. Some potential pros and cons to consider include the following:
Advantages of using a HELOC to pay off your mortgage
Attaining a HELOC can be a savvy way to pay off your house early or reduce your mortgage. Some of the advantages for this strategy include:
- Access to revolving, multi-purpose credit: With a HELOC, you can withdraw the amount you need, when you need it, up to the credit limit. After you’ve repaid your mortgage, you can continue to use your HELOC credit for other purposes, such as for renovations. Some lenders require a minimum initial draw and/or offer incentives to taking an initial draw.
- Flexible repayment: The option to make interest-only payments during the draw period may vary by lender but can free up monthly cash flow for other opportunities and obligations in the short term. In many cases, HELOCs have no prepayment penalties, allowing you to repay what you borrowed at any time.
- Potentially lower interest rates: You may find that the interest rates offered for HELOCs are lower than your mortgage or other refinancing options. Among other things, the interest rate you’re quoted depends on the lender and current rate environment.
Disadvantages of using a HELOC for mortgage repayment
Replacing your mortgage with a HELOC introduces a different type of debt, which may have certain drawbacks. Some potential disadvantages include:
- Rate changes: Most HELOCs have a variable interest rate structure that rises and falls with fluctuations in the federal funds rate. This can result in monthly payments being different amounts throughout the course of repayment.
- Potential fees: Some lenders advertise low- or zero-fee HELOCs, but this is not always the case. Certain lenders may require multiple fees to be paid alongside your HELOC, including (but not limited to) an origination fee, annual fee or inactivity fees.
- Tax disadvantage: While mortgage interest is often tax deductible (when itemized), the same is not true when you use a HELOC to pay off your mortgage early. Bear in mind, funds used from a HELOC for home improvement may be tax deductible. If you have questions, you may want to consult a tax professional.
How to use a HELOC to pay off your mortgage
If you decide to pursue this option, the process of acquiring and using your HELOC is relatively straightforward. After you’ve compared the rates and terms for a few potential lenders, you will need to submit your application for approval. Once approved, the money will be disbursed and can be used to repay your mortgage.
HELOC application and approval
An application for a HELOC typically requires you meet certain approval criteria. Depending on the lender, approval criteria and documents may include:
- Sufficient equity: Lenders will typically lend up to 80% of the combined value of the home, including your first mortgage and the HELOC.
- A good credit score: A score of 620 and above may improve your odds of approval and rates. Generally, the lender will obtain a copy of your credit report themselves, though you may need to authorize them to do so. This is typically a hard credit check, which may impact your score.
- Low debt-to-income (DTI): A maximum DTI ratio of 43% is generally preferred for applicants. You may need to provide credit card statements as well as documentation of your loan balances and monthly payments.
- Adequate income: Income verification may be part of the approval process. To verify that you're being paid enough to support the loan, the lender may require recent pay stubs, IRS W-2 forms or tax returns (for self-employed individuals).
- Homeowner’s insurance: HELOC lenders may require proof of homeowner’s insurance in order to approve you for a loan.
Bottom line
Using a HELOC for mortgage repayment is possible, and for some, a good option to manage cash flow and reduce long-term expenses. Knowing when to pay off a mortgage with a HELOC is a personal decision that requires reflection on one’s financial stability, current situation and the current rate environment. For extra assurance as you pursue this option, you may want to consult with an experienced financial planner or Home Lending Advisor.
