Can You Pay Off Your Mortgage With a HELOC?

Using a Home Equity Line of Credit (HELOC) to pay off an existing mortgage is a financial strategy homeowners sometimes consider. Understanding a HELOC’s mechanics and the steps involved is important for homeowners evaluating this option. This article explains how a HELOC functions, the process of using it to satisfy a mortgage, and the implications for ongoing repayment.

Understanding the Home Equity Line of Credit

A Home Equity Line of Credit (HELOC) is a revolving credit line secured by the borrower’s home equity, functioning much like a credit card. It allows access to funds as needed, up to an approved limit, rather than providing a lump sum upfront. The home itself serves as collateral for the line of credit, which typically offers a lower interest rate compared to unsecured loans due to its secured nature.

A HELOC operates in two distinct phases: the draw period and the repayment period. During the draw period, which commonly lasts between 5 and 10 years, borrowers can access funds, repay them, and then re-borrow again. During this phase, payments are often interest-only on the amount borrowed, though principal payments can also be made. Once the draw period concludes, the repayment period begins, typically lasting 10 to 20 years, during which no new funds can be drawn, and the borrower must make principal and interest payments to amortize the outstanding balance.

The interest rate on most HELOCs is variable, meaning it can fluctuate based on an index, commonly the U.S. Prime Rate, causing monthly payments to change over time. The amount of credit available through a HELOC is determined by the home’s equity, which is the difference between the home’s appraised value and the outstanding mortgage balance. Lenders typically allow borrowing up to a certain percentage of the home’s value, often ranging from 80% to 90% of the combined loan-to-value (CLTV), including the existing mortgage and the new HELOC. Interest is only charged on the amount actually borrowed, not the entire approved credit limit.

The Process of Using a HELOC to Satisfy a Mortgage

Using a HELOC to pay off an existing mortgage starts with the application. Homeowners typically begin by checking their eligibility, which includes having sufficient home equity, a good credit score (often 680 or higher), a manageable debt-to-income (DTI) ratio (preferably below 43%), and consistent income. Lenders require documentation such as recent pay stubs, W-2 forms, tax returns, bank statements, and current mortgage statements to verify financial standing and determine the potential credit limit.

After submitting the application, the lender will likely order a professional appraisal to confirm the home’s current market value, which directly impacts the amount of available equity and the maximum borrowing limit. Once the HELOC application is approved, and all closing documents are signed, the funds become accessible after a short rescission period, typically three business days, during which the borrower can cancel the loan without penalty.

With the HELOC active, the homeowner can then access the necessary funds. This usually involves taking a single large draw from the HELOC for the precise amount needed to pay off the existing mortgage balance. This lump sum is then directed to the original mortgage lender. Upon receiving the full payoff amount, the original mortgage is satisfied, and the lender releases its lien on the property. The homeowner’s primary debt then shifts from the original mortgage to the new HELOC, which is now the sole loan secured by the home.

Managing Repayment After Mortgage Payoff

After a HELOC pays off a primary mortgage, the homeowner’s financial obligations shift to managing the HELOC balance. The previous fixed mortgage payments are replaced by a new repayment structure dictated by the HELOC’s terms. This transition means the homeowner now owes the balance drawn from the HELOC, which becomes the new principal amount.

A primary consideration in managing HELOC repayment is the variable interest rate, which can cause monthly payments to fluctuate significantly. Since most HELOCs are tied to an index like the Prime Rate, changes in the broader economic interest rate environment directly impact the amount due each month. Lenders typically notify borrowers of rate changes through monthly statements, but these adjustments can occur frequently, requiring diligent budgeting.

Another important aspect of HELOC repayment is the transition from the draw period to the repayment period. During the draw period, many HELOCs allow for interest-only payments, which can result in lower initial monthly outlays. However, once this period ends, the repayment phase begins, and payments will increase substantially as they must now include both principal and interest components to fully amortize the loan over the remaining term. This “payment shock” can be significant if not planned for, as the principal balance has not been reduced during the interest-only phase. Homeowners may consider making principal payments during the draw period to mitigate this future increase or explore options to convert a portion of the variable-rate HELOC balance to a fixed rate if offered by their lender.