Can You Use a HELOC to Pay Off Your Mortgage?

A Home Equity Line of Credit (HELOC) allows homeowners to borrow against their home’s equity. Many consider using a HELOC to manage or pay off their existing mortgage, leveraging their home’s value for debt restructuring. This approach involves specific mechanics and financial considerations.

Understanding Home Equity Lines of Credit

A HELOC functions as a revolving line of credit, secured by the equity in a home. Equity is the home’s market value minus outstanding mortgage debt. Borrowers can access funds up to an approved limit, repay, and re-borrow, similar to a credit card.

HELOCs feature two phases: a draw period and a repayment period. The draw period, lasting around 10 years, allows withdrawals and often requires interest-only payments. The repayment period, extending for 10 to 20 years, requires both principal and interest payments. HELOCs have a variable interest rate, which can fluctuate based on an index like the U.S. Prime Rate.

Applying a HELOC to Mortgage Repayment

Using a HELOC to address an existing mortgage involves drawing funds and applying them to the primary home loan’s principal balance. This replaces the original mortgage debt, or a portion of it, with a new debt structure under the HELOC terms. For example, a homeowner might draw a lump sum to pay off their entire first mortgage.

A HELOC can also consolidate first and second mortgages, or replace a primary mortgage with a higher interest rate if the HELOC offers better terms. When a HELOC fully pays off a primary mortgage, it becomes a “first-lien HELOC.” In this case, the HELOC lender gains the primary claim to the property, similar to a traditional mortgage. This differs from a “second-lien HELOC,” which is an additional debt behind the original mortgage.

While a HELOC can offer flexibility, especially with a lower initial interest rate or adaptable payment options, the underlying debt secured by the home remains. The decision to convert a primary mortgage into a first-lien HELOC should align with financial goals and risk tolerance.

Financial Implications of This Approach

The financial implications of using a HELOC for mortgage repayment are varied due to their variable interest rates. Most HELOCs have variable rates, tied to an index like the Wall Street Journal Prime Rate. This means monthly payments can increase or decrease, introducing unpredictability compared to fixed-rate mortgages. Even with introductory low rates, the rate can adjust quickly, sometimes within a month or two of a Federal Reserve rate change.

HELOCs also come with various fees and closing costs, which can range from 2% to 5% of the credit line. These may include application, appraisal, title search, notary, and attorney fees. Some lenders advertise “no closing cost” HELOCs, but these costs are often incorporated into a higher interest rate.

The repayment structure impacts overall cost. During the draw period, minimum payments may be interest-only, not reducing the principal. While flexible, this can lead to a larger principal balance at the start of the repayment period, resulting in higher monthly payments later. The variable interest rate and extended repayment periods could lead to more total interest paid compared to a fixed-rate mortgage. Using home equity for debt repayment also reduces available equity for future borrowing needs.

Eligibility and Application Requirements

To qualify for a HELOC, lenders assess financial factors like creditworthiness and ability to repay. A strong credit score is required, with scores of 740 or above often securing the most favorable rates. Lower scores may still qualify but with less advantageous terms.

Lenders evaluate the loan-to-value (LTV) ratio, comparing the amount owed to the home’s appraised value. A combined LTV ratio (including existing mortgage and proposed HELOC) should not exceed 80% to 85% of the home’s value, meaning homeowners need at least 15% to 20% equity. The debt-to-income (DTI) ratio, measuring monthly debt payments against gross monthly income, is also important, with most lenders preferring a DTI of 43% to 45% or less.

Applicants must demonstrate stable income and employment. Required documentation includes proof of income, such as recent pay stubs, W-2 forms, or tax returns for self-employed individuals. Lenders may also request bank statements, property tax statements, and homeowners insurance policy details.

The HELOC Application and Approval Process

Applying for a HELOC begins with gathering necessary documentation, including personal identification, proof of income, and property details. Applications can be submitted online, in person, or by phone. Once submitted, the application proceeds to underwriting.

During underwriting, the lender reviews the applicant’s financial profile, creditworthiness, and verifies information. A home appraisal is often required to determine the property’s market value and confirm available equity. This appraisal process can take one to two weeks.

Upon successful underwriting and appraisal, the HELOC application moves to approval. The lender presents the loan agreement outlining terms, conditions, credit limit, and interest rate. After the borrower reviews and signs closing documents and pays applicable costs, the HELOC is established. Funds become accessible within a few days to two weeks after closing, often via checkbook or debit card. The entire process generally takes two to six weeks.