If a homeowner has adequate home equity, they might be able to use a HELOC to pay off their mortgage. A home equity line of credit (HELOC) is a secured loan that offers home equity in the borrower’s residence. Unlike a home equity loan, it’s just like a credit card that provides a significant amount.
This can minimize both the total loan interest rate and monthly payments. In addition, this method offers several risks like significant payments when your interest rates increase, and is suitable for homeowners who owe less than their home’s worth. Furthermore, you can reach out to a financial advisor before making any huge decision based on home financing.
How to Use A HELOC to Pay Off Your Mortgage
You can use a HELOC to pay off almost anything, like settling a mortgage, financing home improvements, high-interest rates consolidation, and more. However, it’s not always the right decision regarding the terms of your new HELOC and your first mortgage. In this article, we will discuss how it works and its disadvantages after highlighting how to use HELOC to pay off your mortgage.
Find the best lender
Comparing HELCOs from numerous lenders can assist you in obtaining the best interest rate for the loan amount to want to achieve. By this, you should get a lender that will pay some or all of waive closing costs or will charge little upfront fees.
Apply for HELOC
Unlike a mortgage refinance, the HELOC application process may be less severe and very affordable. In addition, the maximum amount of home equity that you have will depend on your HELOC loan limit.
Obtain a home appraisal
An appraisal of your home is the initial necessary procedure for estimating your home equity. You might be eligible for a virtual home appraisal, depending on the lender and loan amount needed which could reduce your underwriting costs.
Close the loan
The closing documents that disclose your interest rate, costs, and the timeframe of your draw and repayment period will be signed by you. In many circumstances, your finance is available commencing on the fourth business day after closure.
Pay off your mortgage
In this process, you are to withdraw the necessary amount from your credit line to pay off your mortgage balance. In addition, send the money to your mortgage servicer to confirm payment.
Pay the HELOC interest
Since it’s not essential to reimburse interest during the draw period of a HELOC, you have to make a payment. This is because it will help reduce your total interest rate over time.
Repay the HELOC principal
Immediately after the draw period ends, the necessary principal and interest payment begins during the repayment period. Generally, the HELOC repayment period lasts between 10 to 20 years.
Since most lenders offer fixed-rate HELOCs, you should expect to have a variable interest rate for the loan duration. Additionally, these have higher initial interest rates unlike variable-rate HELOCs, but paying additional interest over time won’t be necessary. Furthermore, there are various ways to refinance a HELOC to minimize the total cost of borrowing or to get better repayment terms if interest rates are lower in the future.
When to Use HELOC to Pay Off Mortgage
The period to use HELOC to pay off a mortgage does not depend on a fixed equity amount or principal fee. It depends on the amount of equity you begin with, the amount of home you reimbursed in cash the size of your down payment, and your outstanding mortgage balance amount. Furthermore, the period you have been making payments, the more equity you have enhanced and can access.
However, it only comes down to interest rates. If you can obtain a huge reasonable interest rate on a credit line than you have with your current mortgage, you can use HELOC to pay off the mortgage. This is because the variable rate on HELOC should be less than your mortgage rate. This is to make way to go upward before you reach that rate to be financially advantageous. Also, it might be hard to make this estimation work since HELOCs have higher rates than mortgages.
When Not to Use HELOC to Pay Off Mortgage
If HELCO’s interest rates are higher than those on your existing mortgage, you should not use HELOC to pay off your mortgage. Despite being minimal, you might end up paying additional interest over time than you would have with your existing mortgage with HELOC variable rates. Additionally, if you specify deductions on your tax return, you can get a tax consideration.
While mortgage loan interest is deductible, HELOC interest that is used to repay a mortgage would not be as you might need to use the money to buy, repair, or improve your home. Also, you should consider your level in mortgage terms, regardless if HELOC interest rates are very low. You might consider using it if the loan reaches where most of your payments are sent to the principal.
Risks of Using HELOC to Pay Off Mortgage
Using HELOC to pay off your mortgage involves various that you might need to consider. This is a case where your home becomes collateral, if payments are made on time. Variable interest rates are typical features in HELOC, which makes payments get higher. By considering the following risks, you can make a reasonable decision on whether it’s suitable for your financial objectives and situation.
Fluctuating rates
Since HELOCs have variable interest rates, your rate will change over time in response to changes in the market. You must be ready to accommodate larger payments into your budget because it is impossible to forecast whether your rate will increase or decrease in the future.
Additional debt
Although HELOC can be used to pay off a mortgage, doing so would result in the addition of new debt, which could result in higher interest rates than with the original mortgage. This may affect your credit score and finances, particularly if you aren’t saving money over time.
Penalties and fees
Aside from interest rates, obtaining HELOC involves expenses like yearly charges and possible early payback penalties. These have the potential to greatly raise the total cost of the loan, making it more expensive than expected. It is important to be aware of these additional costs because they directly affect how affordable the loan is and may offset the advantages of utilizing a HELOC to pay off your mortgage more quickly.