How to Use a HELOC to Pay Off Your Mortgage Faster

A Home Equity Line of Credit (HELOC) allows individuals to borrow against their home’s accumulated equity, providing access to funds for various purposes. One strategic application of a HELOC involves accelerating the payoff of a primary mortgage. This approach can reduce total interest paid and shorten the mortgage repayment timeline.

Understanding a Home Equity Line of Credit

A HELOC is a revolving line of credit secured by your home’s equity. Equity represents the difference between your home’s current market value and your outstanding mortgage balance. Similar to a credit card, a HELOC allows you to borrow funds as needed, up to a set maximum credit limit, and you only pay interest on the amount you actually use. This contrasts with a traditional home equity loan, which provides a single lump sum upfront.

HELOCs feature variable interest rates, which fluctuate based on market conditions. The lifespan of a HELOC is divided into two main phases: the draw period and the repayment period. During the draw period, you can access funds, make interest-only payments, and repay borrowed amounts to free up available credit again.

Once the draw period concludes, the HELOC transitions into the repayment period. In this phase, you can no longer withdraw funds, and you are required to make payments that include both principal and interest on the outstanding balance. The shift to principal and interest payments can lead to higher monthly obligations compared to the interest-only payments of the draw period.

Applying for a Home Equity Line of Credit

Obtaining a HELOC requires an application process that assesses your financial standing and home equity. Lenders require applicants to have sufficient equity in their home, typically at least 20%. Some lenders may allow borrowing up to 85% or even 90% of your home’s value, minus the outstanding mortgage. A solid credit score is also important, with many lenders looking for a FICO score of 680 or higher.

Lenders will also evaluate your debt-to-income (DTI) ratio, which compares your monthly debt payments to your monthly gross income. A DTI ratio below 43% is preferred to ensure you can manage additional debt. The application requires documentation such as proof of income, employment verification, and a list of current debts and assets. A professional home appraisal is required to determine your home’s current market value and the available equity.

After submitting your application and supporting documents, the lender will review your financial profile and the appraisal results to determine approval and the credit limit. If approved, you will sign loan documents.

The Mortgage Acceleration Strategy

This strategy uses a HELOC’s flexible access to capital and its interest calculation method to accelerate mortgage payoff. The idea is to make a lump-sum payment to your primary mortgage using HELOC funds. This principal reduction decreases the outstanding balance of your mortgage, leading to interest savings over the remaining loan term.

Once the mortgage principal is reduced, the focus shifts to paying down the HELOC balance. HELOC interest is calculated daily on the outstanding balance. Every payment directly reduces the principal on which interest accrues, leading to interest savings. This differs from traditional mortgages, where interest is usually calculated monthly. By consistently applying extra income or savings directly to the HELOC, you can rapidly reduce its balance.

This approach is most effective when the HELOC’s interest rate is lower than your primary mortgage rate, allowing you to “refinance” a portion of your mortgage at a more favorable rate. The ability to make frequent, principal-reducing payments on the HELOC can still accelerate debt payoff. Mortgage recasting recalculates your monthly mortgage payment based on the reduced principal balance, without changing the interest rate or original loan term. This strategy requires financial management to ensure the HELOC is paid down swiftly, preventing the accumulation of variable-rate interest.

Managing Your HELOC and Mortgage Payments

Managing your HELOC and mortgage payments is key for this acceleration strategy. After using HELOC funds to reduce your mortgage principal, your focus shifts to repaying the HELOC balance. During the draw period, you might only be required to make interest-only payments. Making additional principal payments during this phase can reduce the overall interest paid and free up your available credit more quickly.

Monitor the variable interest rate of your HELOC, as these rates can change based on market conditions. Rate fluctuations can lead to changes in your monthly payment. If interest rates rise, your payments could become higher, particularly when the HELOC transitions to the principal and interest repayment period.

Maintain financial discipline to ensure your overall debt decreases rather than increases. This involves consistently channeling surplus funds towards the HELOC balance. Track both your outstanding HELOC balance and your remaining mortgage principal to verify progress toward your payoff goals. If financial challenges arise, explore options such as contacting your lender for hardship programs or refinancing the HELOC into a fixed-rate home equity loan or a new mortgage.