HEOC pays off mortgage and other news

Published by
Peter Kavinsky

Despite changes in the housing market, many borrowers today have significant capital in their homes. If you’re one of them, you might be wondering if it makes sense to use a Home Secured Line of Credit (HELOC) to pay off your mortgage, especially if you don’t owe a lot on your home. Here’s what you need to know about paying off your mortgage with HELOC and the risks involved.

Can HELOC help you pay off your mortgage?

HELOC funds can be used to pay off a mortgage loan. If you have a lot of equity in your home and don’t have much left to pay off your loan, you can even pay it off in full with a line of credit.

HELOCs work by allowing you to use your home’s equity to raise funds for any purpose or purpose, such as home improvements, education, or even emergencies. Depending on your level of capital, you will be approved for a certain amount, which you can borrow in whole or in part during the HELOC draw period, usually 10 years. During this time, you will pay interest on the loan at a variable rate. After the draw period, you will need to repay what you have borrowed (with any interest), usually over a 20-year period.

Pros and cons of using HELOC to pay off your mortgage

pros

  • Chance for a lower rate: If your current mortgage has a higher interest rate and HELOC has a lower interest rate, you can use funds from HELOC to pay off your mortgage sooner for less money. However, this largely depends on the broader mortgage market – right now, rates are rising on all types of loans, including HELOC. Compare current HELOC rates.
  • Flexibility: HEOC is a more flexible form of funding because you can only take what you need, rather than the entire amount you were approved for. For example, if you don’t want to use all of HELOC’s money to pay off your mortgage, you might decide to use some of the money for home repairs or other expenses, or not borrow it at all.
  • Low or zero closing costs: While the cost of closing a HELOC is typically 2 to 5 percent of the amount you borrow (similar to a mortgage), the cost can be lower compared to a cash refinance because you are likely to borrow less. Some lenders even offer HELOC without closing costs.

Minuses

  • Variable rate: HEOCs have a variable interest rate, which means your rate will fluctuate over time based on market conditions. It’s impossible to predict if your rate will go up or down in the future, so you need to be prepared for higher payouts in your budget.
  • More debt: While HELOC may pay off your mortgage, you will also replace that debt with another form of debt, and you may end up paying more interest than you would on your current mortgage. This has implications for your credit score and finances, especially if it doesn’t help you save money in the long run.
  • Fees and fines: Many HELOCs have an annual fee and some have a prepayment penalty if you pay it off earlier than the repayment schedule.
  • Flexibility: The flexibility of HELOC can also be a disadvantage, as it can tempt you to spend impulsively or otherwise overstretch yourself financially.

An example of using HELOC to pay off a mortgage

Let’s say 20 years ago you took out a $300,000 mortgage for 30 years at 6.5%. Today your balance is $164,107 and your home is currently valued at $675,000. This means you have $510,893 of net worth. You will only need to borrow about 30 percent of that amount with HELOC to pay off the mortgage balance.

Should I pay off my mortgage early with HELOC?

While you can use HELOC to pay off your mortgage, it does have limitations. HELOC lenders usually allow you to borrow up to 80 percent (sometimes 85 percent) of your home’s value as a line of credit. Depending on your specific financial performance, this may not be enough to pay off your mortgage in full.

Any funds you use from HELOC must also be repaid, usually within a repayment period of up to 20 years. If you’re close to paying off your current mortgage, you may not want to commit to paying off another debt for a few more years, especially if you’re nearing retirement or are retired and have a fixed income.

The variable rate is also reason enough to pause. The Federal Reserve has said it intends to keep raising its key rate in 2022, which means higher HELOC rates.

“HELOC variable rate clients can easily see their interest rates rise significantly,” says Herman (Tommy) Thompson Jr., CFP, of Innovative Financial Group in Atlanta. “It is also unlikely that the interest rate on HELOC in 2022 will actually be lower than on mortgages taken out over the past 20 years.”

Alternative ways to prepay or pay off your mortgage

If your goal is to pay off your mortgage early, you may be better off making additional payments if possible, or, alternatively, taking out a home loan. When making additional payments, you can choose to pay a lump sum or start making payments every other week. With a home secured loan, you’ll get a fixed rate (compared to a variable rate with HELOC), which means your monthly payments won’t change. However, you are still borrowing money to repay the borrowed money, which is not ideal. Consider this and HELOC carefully if you want to get out of your mortgage faster.

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Peter Kavinsky

Peter Kavinsky is the Executive Editor at cablefreetv.org

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