Purchasing a home is a big financial decision. For many, it can be the most important financial decision they make. However, owning the home outright can feel like an unattainable goal while trying to pay the mortgage down.
Though this can take many years, people are finding financially creative ways to pay off mortgages more quickly. One such way is using a HELOC to pay off the mortgage. However, is it risky? As homeowners assess their financial options, it’s important to weigh the risks involved and whether the payoff is worth it. If you’re considering taking out a HELOC to pay off your mortgage, read below for helpful insight.
Understanding a HELOC
Before weighing potential cost versus benefit, it’s important to understand what a HELOC is. A HELOC is a home equity line of credit, which works similarly to a credit card.
A line of credit enables a borrower to take out money as needed. Then, once the borrower pays off the outstanding balance, the full credit is available again. You can withdraw and repay as many times as necessary. The ability to withdraw as little or as much as needed, versus taking out a large lump sum at once, has numerous benefits. These benefits range from flexibility to potentially lower interest rates.
In order to qualify for a HELOC, you must have available equity in your home. If you owe less than the value of the home, you may be able to borrow against the equity. Sometimes, this can be upwards of 85 percent of your home’s value. However, the amount you owe will have to be factored in and subtracted from this percentage.
Since you’re borrowing against the equity of your house, the house is used as collateral. The risk you must consider when using your home as collateral is that you could lose it if you fail to make payments resulting in default. Using your home as collateral is common practice, but you should consider your financial stability and credit history before making this decision.
How can you use a HELOC to pay off your mortgage?
To assess whether using a HELOC to pay off a mortgage is the right financial decision for your household, you must familiarize yourself with the process.
First, check the amount that’s available to borrow. It should be equal to or greater than the amount you owe. Once you’re approved, take the amount needed and send it immediately to your mortgage lender. Then you can either start repaying the HELOC’s interest and principal, or pay interest only until the loan is in repayment.
If you’re going to use a HELOC to pay off your mortgage, you need to have a positive cash flow. Essentially, your monthly income must be greater than your expenses. If your monthly income is stable, you may have more success with this method.
For those with a low income or a very tight budget, you may choose to consider other options to paying off your mortgage faster. These options include refinancing at a lower mortgage rate. If you have a mortgage loan through a credit union, refinancing your mortgage can be easy. Don’t worry if you aren’t a member of a credit union yet – becoming a member is easy. One you qualify, financing with a credit union for lower rates is still possible when you join one.
There are other advanced strategies as well. If you’re interested in these, some use a HELOC as part of a mortgage accelerator program. If your monthly income is greater than your expenses, in certain months you will put your entire paycheck toward your mortgage. Those select months, the rest of your expenses will go on a credit card with a 45-day grace period.
After the grace period, transfer the credit card balance to the HELOC and use your next paycheck to pay off the HELOC balance. Once that paycheck is allocated to the HELOC, the following paycheck is applied to your mortgage and you repeat the cycle again.
If advanced strategies and mortgage accelerator programs sound too complicated, don’t worry. Even without these accelerator programs, a HELOC can still be applied more simply by using the full amount toward your mortgage and paying interest plus principal.
Are there risks involved?
Every loan poses some degree of risk. It’s important to evaluate which ones you’re most comfortable with. If you chose to use your HELOC to pay off your mortgage and fall behind on payments, your lender can foreclose. However, this is also the case if you default on your mortgage.
Additionally, if you borrow the full amount available against your equity, you’ll still have to pay the same principal amount.
This method of mortgage repayment may be best suited for someone who has more equity than debt in their property. Also for those that can get a lower rate with a HELOC than their current mortgage, and has a stable income with positive cash flow. If you’re operating on a tight budget and have a lower monthly income, you may want to contact your lender to explore other options.
Benefits of Using a HELOC to Pay Off Your Mortgage
Using a HELOC to pay off your mortgage may be a viable option if you qualify for competitive interest rates. Over time, you may end up paying less. Traditional mortgage loans can accrue a lot of interest, as they usually take homeowners many years to pay off.
Though you will still have to pay interest on a HELOC, these loans can often be obtained at lower rates. If you’re able to pay off the mortgage faster, less interest is accrued. This will save you money and lower the cost of the property.
A HELOC also offers flexibility. You aren’t required to borrow the remaining amount. Or, if you have more available than what’s necessary to repay your mortgage, you can use the remaining balance to renovate. By doing this, you will build more equity with the increased value of your home.
If you’re interested in tapping into your equity or other forms of loans, consider becoming a member of Central Willamette Credit Union. They’re all about serving their members and helping them on their financial journey. Feel free to contact them today! They’re happy to help answer your questions and meet your home loan needs.
Understanding your financial situation and how loans work will help you better determine which method of paying off your mortgage is right for you. With the right strategy, you can be on your way to owning your home debt-free.