Consider a HELOC to Pay off Your Mortgage

If you have built up equity in your home but still have a mortgage balance to pay off, you may consider using a home equity line of credit (HELOC) to reduce your monthly payments and the overall interest you pay on your loan. Since HELOCs sometimes have lower interest rates than mortgages, you could save money and potentially pay off your mortgage sooner. Even if the rates are similar, refinancing your first mortgage with a HELOC might still be the best choice for you.

Here are some pros and cons of using a HELOC to pay off your mortgage as opposed to a traditional refinance.

Like a mortgage, a HELOC is secured by the equity in your home. Unlike a mortgage, a HELOC offers flexibility because you can access your line of credit and pay back what you use just like a credit card.

You can use a HELOC for just about anything, including paying off all or part of your remaining mortgage balance. Once you get approved for a HELOC, you could pay off your mortgage and then make payments to your HELOC rather than your mortgage. Note that HELOC rates are variable, which means the rate can fluctuate up or down and is tied to a known index, usually the prime rate.

Using a HELOC to pay off your mortgage is essentially a form of refinancing. It allows you to reduce your interest rate without the closing costs associated with a home refinance.

Before you decide on a HELOC, there are several things to consider:

• Your current mortgage
  • How much do you still owe?
  • How long would it currently take you to pay it off?
  • What are your monthly payments?
• Your options with a HELOC
  
  • What will your monthly payments be?
  • Do you have the option to pay interest only?
  • How long do you intend to make payments on your HELOC?
  • Will you have the discipline to make additional payments towards the principal of your HELOC balance?
• Your other borrowing options
  • What would your interest savings be under a typical refinance?

The interest-only repayment option is an attractive feature of a HELOC. However, at the end of the draw period, the interest and principal will be rolled into one amortized monthly payment for a loan term of 15 years. You have to be prepared for this or the increase in your monthly payment (which will now include principal as well as interest) could catch you by surprise and hurt your finances.

You could choose to make payments toward the principal each month to space these out rather than have the large payment at the end. Since these are not automatically included in your monthly bills, you will need to let your lender know how much you want to apply to the principal. Look into your loan agreement to find out if there are any prepayment penalties. These usually apply only if you actively pay off and close your account. Generally, small monthly payments will not affect these penalties, but you'll want to be sure.