Can You Get a HELOC to Pay Off Another HELOC?

A Home Equity Line of Credit (HELOC) functions as a revolving line of credit that allows homeowners to borrow against the equity they have built in their property. Similar to a credit card, a HELOC provides access to funds up to a predetermined limit, which can be drawn upon as needed. The home itself serves as collateral for this type of loan, meaning it secures the debt.

Homeowners often utilize HELOCs for various purposes, such as funding home improvements, covering educational expenses, or consolidating other debts. A key feature of a HELOC is its flexibility, enabling borrowers to access funds, repay them, and then re-borrow again during a specified “draw period.” This financial tool can offer more favorable interest rates compared to unsecured loans, given that it is backed by a significant asset.

Feasibility of Using One HELOC to Pay Another

It is generally possible to use a new Home Equity Line of Credit (HELOC) to pay off an existing one. This process is not a direct transfer of debt but involves applying for and securing a completely new HELOC. If approved, the funds obtained would then be used to satisfy the outstanding balance of the original HELOC. The new HELOC essentially replaces the old one, providing a fresh set of terms and conditions.

Homeowners pursue this option for various reasons, including seeking a lower interest rate, a longer draw period, or more favorable repayment terms. Lenders evaluate a new HELOC application based on current home equity, creditworthiness, and debt-to-income ratios, among other factors. The process is akin to applying for any new loan, requiring a full underwriting review and meeting eligibility requirements.

Key Considerations for a New HELOC Application

Before applying for a new HELOC to pay off an existing one, homeowners must assess several factors lenders use to determine eligibility.

Home Equity

A primary consideration is the amount of home equity available in the property. Lenders typically allow borrowing up to a certain percentage of the home’s value, often ranging from 80% to 90%, minus any outstanding mortgage balances. Equity represents the difference between the current market value of the home and the amount owed on all mortgages and liens.

Creditworthiness

Creditworthiness plays a significant role in the approval process. Lenders examine an applicant’s credit score, which should ideally be above 640, though higher scores like 680 or 720 and above can lead to more favorable terms. A strong credit history, demonstrating consistent on-time payments and responsible debt management, is also important. The lender will review the applicant’s credit report for any delinquencies, bankruptcies, or high credit utilization.

Debt-to-Income Ratio

Another important metric is the debt-to-income (DTI) ratio, which measures the percentage of gross monthly income that goes towards debt payments. Lenders typically prefer DTI ratios below 43% to 50%, as a lower ratio indicates a greater ability to manage additional debt. This calculation includes all recurring monthly debt obligations, such as mortgage payments, car loans, student loans, and credit card minimums, in relation to gross monthly income.

Income Stability

Lenders also assess income stability to ensure the borrower has a reliable source of funds to make future payments. This often involves verifying employment history, reviewing pay stubs, and examining tax returns. Consistent employment over several years and a steady income stream strengthen an application.

Home Appraisal

An appraisal of the home is almost always required to determine its current market value. This valuation helps the lender calculate the available equity and the maximum credit limit for the new HELOC. Appraisal fees typically range from $300 to $600, although some lenders may waive this cost as part of a promotional offer.

Associated Costs

Homeowners should account for various associated costs when obtaining a new HELOC. These can include origination fees, which are upfront charges for processing the loan, and closing costs that might range from 0% to 5% of the credit limit. Other potential charges include title search fees, attorney fees, and property insurance premiums.

The Process of Refinancing with a New HELOC

The process of securing a new HELOC to pay off an existing one begins with the application submission. This typically involves completing a detailed application form, which can often be done online, in person, or over the phone. Required documentation generally includes recent pay stubs, W-2 forms or tax returns, bank statements, and property details.

Following submission, the application moves into the underwriting phase, where the lender thoroughly reviews all provided information. During this stage, the lender conducts a credit check to assess the applicant’s credit history and score. They also verify income and employment details and order a new appraisal of the property to establish its current market value and confirm available equity.

Upon successful underwriting and approval, the homeowner proceeds to the closing procedures. This involves signing legal documents, including the new HELOC agreement, promissory note, and various disclosure statements that outline the terms and conditions of the loan. Borrowers typically have a three-business-day right of rescission after closing, during which they can cancel the agreement without penalty.

After the rescission period, the funds from the new HELOC are disbursed. The method of disbursement can vary; sometimes the funds are directly transferred to the borrower’s checking account, or the new lender may send the funds directly to the servicer of the existing HELOC to pay off the prior HELOC in its entirety. Once the existing HELOC is paid off, the previous lender will release the lien on the property associated with that line of credit.

Understanding the Financial Impact

Securing a new HELOC to pay off an old one brings about distinct financial changes. The new HELOC will come with its own interest rate, which is typically variable, meaning it can fluctuate based on a chosen index, such as the U.S. prime rate, plus a margin set by the lender. This new rate may be higher or lower than the previous HELOC’s rate, directly impacting the cost of borrowing. Additionally, the new HELOC will have a specific draw period, usually 5 to 10 years, followed by a repayment period, often lasting 10 to 20 years.

The overall cost of borrowing will be influenced not only by the new interest rate but also by any closing costs associated with the new HELOC. These upfront fees, such as origination charges or appraisal costs, add to the total expense of the transaction. While a new HELOC might offer a lower interest rate, it is important to calculate whether the savings on interest outweigh these new fees over the life of the loan.

Consequently, the monthly payment amount will change, reflecting the new interest rate, the outstanding balance, and the new repayment schedule. During the draw period, payments might be interest-only, but they will likely increase significantly during the repayment period when principal payments become due. Homeowners must ensure the new monthly payment is manageable within their budget.

There are also credit score implications to consider. Opening a new HELOC will result in a hard inquiry on the credit report, which can cause a temporary, slight dip in the credit score. However, successfully paying off the old HELOC and establishing a positive payment history with the new one can positively impact the credit score over the long term by reducing overall credit utilization and demonstrating responsible debt management.