If you would like to reduce the amount you have to pay in interest or pay off your mortgage sooner, you might be thinking about refinancing. A home equity line of credit is another avenue worth considering.
How Does a HELOC Work?
If you have accumulated a significant amount of equity by paying down your mortgage, you can take out a home equity line of credit and access a portion of your equity. In some respects, a HELOC is similar to a credit card. You get a line of credit, and you can use as much or as little of it as you want, at one time or at several different times. You will have to repay the amount you use, plus interest.
A HELOC has a draw period when you can use your line of credit. During that time, you will have to make interest payments, and you might also have to repay some of your principal balance.
After the draw period ends, you will have to pay for both principal and interest. If you only make interest payments during the draw period, your required monthly payments can skyrocket once you enter the repayment period.
How Can You Use a Home Equity Line of Credit to Pay off Your Mortgage?
If you take out a HELOC, you might get a high enough line of credit to pay off your existing mortgage. Essentially, you will refinance your current loan and transfer the outstanding balance to a home equity line of credit.
Is That a Good Idea?
The interest rate on a HELOC might be lower than the rate on your mortgage. Even a small difference can have a significant impact on the total amount you’ll have to pay in interest between now and the time when you pay off your remaining balance. Since a HELOC has a variable interest rate, there’s no guarantee that you’d save money in the long run, however.
If you refinance your mortgage, you’ll have to pay closing costs, which can be several thousand dollars. If you take out a home equity line of credit, you won’t have to worry about closing costs.
You’ll need to be disciplined if you use a HELOC to pay off your current mortgage. When you’re in the draw period, you will be able to make smaller payments that only cover interest and possibly some of your balance, but that can get you into trouble later on.
Eventually, you’ll reach the repayment period and will have to pay off the principal. If you don’t chip away at your balance during the draw period, you may be overwhelmed when you reach the repayment period and your payments jump.
If you don’t think you would be disciplined enough to pay down your principal during the draw period, consider taking a different route. You might find that you can refinance your mortgage to a lower interest rate with low closing costs. Look into a variety of options before deciding.
