Should You Use an Equity Loan 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.

Paying off your mortgage is a major financial milestone that many homeowners dream of achieving. As enticing as being mortgage-free sounds, paying off your home loan early requires having access to a large sum of cash. One way homeowners sometimes get their hands on enough money to pay off their mortgage is by taking out an equity loan. But is using an equity loan to pay off your mortgage a smart move?

In this comprehensive guide we’ll explain what equity loans are how they work, and the pros and cons of using one to pay off your mortgage ahead of schedule. We’ll also provide tips for determining if an equity loan makes sense for your unique situation.

What is a Home Equity Loan?

A home equity loan is a type of loan that allows you to borrow money using the equity in your home as collateral. Equity represents your ownership stake in the home. You build equity over time by making mortgage payments and as your home appreciates in value. Lenders will let you borrow up to a certain percentage of your available home equity, often around 85%.

With a home equity loan, you receive the loan proceeds in a lump sum The loan has a fixed interest rate and a set repayment schedule. Your home acts as security for the loan Failure to repay the equity loan could result in foreclosure.

How Do Home Equity Loans Work?

Here’s a quick rundown of how home equity loans work:

Determine your home equity: To qualify for a home equity loan, you first need to calculate your home equity. Do this by finding your home’s current market value and subtracting any outstanding mortgage debt.
Apply for the loan: The lender will require information about your income, existing debts, credit score and home value to determine the loan amount and interest rate.
Get approved: If approved, the lender disburses the loan proceeds to you in a lump sum. This cash can then be used to pay off your existing mortgage.
Repay the equity loan: You’ll make monthly payments on the equity loan based on the repayment schedule. The home acts as collateral, meaning foreclosure is possible if you default.

Pros of Using an Equity Loan to Pay Off a Mortgage

Taking out an equity loan to pay off your mortgage ahead of schedule offers a few potential benefits:

Lower interest rate: If rates have dropped since you got your mortgage, an equity loan could have a lower rate, reducing your overall interest costs.
Consolidate debts: You may be able to roll other debts like credit cards or student loans into the equity loan at a lower rate.
Shorten loan term: Paying off your mortgage early lets you own your home free and clear sooner.
Build equity faster: With your mortgage paid off, all future payments go directly toward building home equity.
Increase cash flow: Eliminating your mortgage frees up money to save or spend elsewhere.

Cons of Using an Equity Loan to Pay Off a Mortgage

There are also some potential drawbacks to using an equity loan to pay off your home loan early:

Closing costs: You’ll likely have to pay closing costs to take out the equity loan, reducing potential savings.
Prepayment penalties: Your current mortgage may charge early repayment penalties.
Interest rate variability: Home equity loans have fixed rates, but HELOCs have variable rates that could increase.
Risk of foreclosure: Your home secures the equity loan, meaning you could lose it if you default.
Difficulty qualifying: Homeowners with significant outstanding debts may not qualify for enough equity to pay off their mortgage.
Temptation to overspend: Having a lump sum of cash on hand could lead some borrowers to overspend.

Tips for Deciding if an Equity Loan is Right for You

As you weigh using a home equity loan to pay off your mortgage early, keep these tips in mind:

Calculate potential savings after accounting for all fees and closing costs. The costs should be recouped within a reasonable timeframe.
Make sure you understand the terms of the equity loan thoroughly. Know the interest rate, loan length, payment amount, and any prepayment penalties.
Be conservative with the loan amount. Borrow only what you need to pay off your mortgage to limit risk.
Have a solid repayment plan in place for the new equity loan before moving forward with it.
Avoid the temptation to use equity loan proceeds for unnecessary purchases. Stick to only paying off your mortgage.
Consult a financial advisor to determine if accessing home equity is the right move for your situation. Get an expert opinion before deciding.

Who Should (and Shouldn’t) Use an Equity Loan?

In general, a home equity loan to pay off your mortgage may make the most sense for:

Homeowners with significant equity built up
Those whose income is stable and reliable
Borrowers with strong credit who can qualify for a low equity loan rate
People who got their mortgage when rates were higher than today
Homeowners who want to pay off their mortgage faster

Using home equity is riskier for and generally not recommended for:

Recent home buyers who have little equity accumulated
People with high existing debts and lower credit scores
Those with variable incomes or unsteady jobs
Homeowners who may want to move soon
Anyone without enough equity to pay off their full mortgage balance

Alternatives to Paying Off Your Mortgage With an Equity Loan

Beyond taking out an equity loan, a couple other options for paying off your mortgage early include:

Making extra mortgage payments – Increasing your regular mortgage payment by any amount can help you pay off your home loan faster.
Refinancing – You may be able to qualify for a lower mortgage rate through a refinance, reducing interest costs without needing to tap home equity.
Using your savings – If you have enough in savings, consider withdrawing funds to make a lump-sum mortgage payment. No loan needed.

The Bottom Line

Tapping into your home’s equity via an equity loan can be a viable way to free yourself from your mortgage early in the right circumstances. But make sure you understand the risks and weigh the pros and cons carefully before choosing this route. Getting professional advice on whether it aligns with your broader financial goals is recommended. With proper planning, an equity loan could accelerate your path to mortgage payoff.

Ready for Citizens FastLine®?

Refinancing your home equity loan could result in many benefits including helping you to reduce your monthly payments.

Important HELOC factors to consider

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 youll want to be sure.

HELOC to Pay Off Mortgage

FAQ

Can I use my equity to pay off my mortgage?

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.

Is a home equity loan a good idea to pay off debt?

Using a home equity loan for debt consolidation will generally lower your monthly payments since you’ll likely have a lower interest rate and a longer loan term. If you have a tight monthly budget, the money you save each month could be exactly what you need to get out of debt.

Can you get equity release to pay off a mortgage?

Equity release can be helpful if you want to repay an existing mortgage, increase your income or pay for care needs. You may also choose to use equity release to help you pay debts that you owe.

What is the monthly payment on a $50,000 HELOC?

Assuming a borrower who has spent up to their HELOC credit limit, the monthly payment on a $50,000 HELOC at today’s rates would be about $375 for an interest-only payment, or $450 for a principle-and-interest payment.

Can I pay off my mortgage early with a HELOC?

Using a home equity line of credit (HELOC) is an unconventional approach to paying off your mortgage early. While tapping your home equity to reduce your home loan balance has several potential benefits, it’s not an ideal option for every homeowner. Is It Possible To Pay Off Your Mortgage With a HELOC? Yes, as long as you have sufficient equity.

Can you use home equity to pay off a mortgage?

What you need to know about using home equity to finish your mortgage Should You Use Home Equity To Pay? You can tap your existing equity to pay off your mortgage, but should you? Learn about your options, including a HELOC, refinance, and home equity loan.

What happens if you pay off your mortgage with equity?

For example, if you’ve paid off a portion of your mortgage, the total value of the home equity loan or HELOC you need to pay off the remainder of your balance will be lower than your starting mortgage value. As such, you may qualify for lower monthly payments by paying your mortgage off with your equity.

Can a home equity line of credit pay off a mortgage?

However, using a home equity line of credit (HELOC) to do so has limitations. First of all, lenders typically only allow you to borrow up to 80 percent (sometimes 85 percent) of your equity in your home via a line of credit. Depending on your specific financials, this might not be enough to pay off your mortgage entirely.