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A home equity loan and home equity line of credit (HELOC) are valuable tools that can help you get cash from your home’s home equity. You can use a home equity loan or HELOC to pay for any large expense, such as a home improvement project.
In some situations, these home equity financing options can lower your monthly mortgage payments or even allow you to pay your mortgage ahead of schedule. Before you begin the process, make sure you understand how to use a home equity loan and HELOC to pay your mortgage and whether it will save you money in the long run.
Credible makes it easy to obtain a HELOC through lending partners.
How HELOCs work
Unlike home equity loans, which give you a lump sum of money, HELOCs give you access to a line of credit. In this way, HELOCs work like a credit card, allowing you to withdraw money as needed up to your maximum limit.
Generally, you cannot borrow more than 85% of your combined loan-to-value (CLTV) ratio. The CLTV measures the amount of your current mortgage balance plus the amount you want to borrow against the equity in your home.
HELOCs generally come with variable interest rates and two terms:
- Draw period — During this period, which is typically 10 years, you can access your line of credit as needed up to your limit and make interest payments only on the loan amount.
- Repayment period – This period, which lasts from 10 to 20 years, begins once the withdrawal period expires. You can no longer access the funds during this time and must make monthly installment payments that include principal and interest.
How to use a HELOC to pay your mortgage
Obtaining a HELOC to pay off or eliminate your original mortgage is an option, but not something everyone should consider. You can save money if you have substantial equity and can get a lower interest rate, but often the problem is in the details. Consider this example:
Let’s say your house is worth $500,000 and the remaining balance on your mortgage is $100,000. He obtained the mortgage 25 years ago with an interest rate of 6% and monthly payments of $2,398.20. if you continue pay your house Over the next five years, you’ll pay $19,843 in total interest charges over that time period.
But what if you qualify for a $100,000 HELOC with no closing costs, a 3.99% variable interest rate, a five-year draw period, and a 15-year repayment term? Here are two options for paying off your original mortgage with a HELOC.
Refund the HELOC within the drawing period
With this option, you could still pay off your house in five years, make lower monthly payments, and save on interest. His monthly principal plus interest payments would be $1,841.20, about $557 less than what he was earning on his original mortgage. In addition, he will pay $10,427 in interest on his HELOC, $9,416 less than he would have paid on his original mortgage.
Remember, however, that HELOCs are variable rate products, which means that your APR and monthly payments could increase with any increase in the interest rate. Some lenders now offer Fixed Rate HELOCthat might be a better option.
Also, keep in mind that some lenders impose prepayment penalties, so be sure you understand the terms of any HELOC you’re considering before implementing this strategy.
Pay the minimum during the draw period
If your income is less than in the past, you can choose to make minimum interest payments only during the withdrawal period. Using the example above, your minimum payment rises to $332 before rising to $739 over the 15-year payment period.
In this case, you create significant space in your budget, lowering your monthly payment by about $2,066 during the draw period and $1,659 during your payment term. The problem, of course, is that you’re paying interest over a much longer period of time—15 more years to be exact—and you’ll be paying over $53,000 in total interest.
Again, these numbers do not take into account any rate increases that may arise with a variable rate HELOC. With this option, you’ll pay more in interest than with your original mortgage, but it may create room in your budget.
Should you use a HELOC to pay your mortgage?
The choice to obtain a HELOC to pay your mortgage will depend on your unique financial circumstances. If you have a low remaining balance on your mortgage and can get a lower interest rate, this option may make financial sense.
On the other hand, if you don’t have a lot of equity and already have a low interest rate, you may not be able to get a HELOC with a low enough APR to make it worth your while.
Also, a variable rate HELOC is generally not a good option if your income is spotty or irregular. Experiencing a drop in income when interest rates rise can make it difficult to budget your monthly payments. If you can’t make your payments, you risk losing your home, since your home insures your HELOC.
Other things to consider are the startup costs and annual fees that often come with a HELOC, including:
- appraisal fees
- Application costs
- closing costs
- annual dues
- inactivity fees
- Commissions for prepayment
How to get a home equity loan
A home equity loan may be a better option if you don’t need access to money for an extended period of time. Home equity loans offer a one-time, one-time payment, which could be all you need to pay for a new roof, install a pool, or finance any other major home improvement. Follow these steps to find a home equity loan that meets your needs:
- Determine the amount you want to borrow. Understanding how much money you need to achieve your goal will help you when you shop and compare loan deals.
- Calculate the value of your home. You will need at least 15% to 20% equity to qualify for a home equity loan. To determine how much equity you have, subtract your current mortgage balance from the market value of your home.
- Shop and compare rates from multiple lenders. Interest rates and payment terms vary by lender, so it’s worth comparing several loan offers to find the right one. best rate and terms to you.
- Submit your request. Once you’ve chosen a lender, you’ll want to fill out an application and provide requested documentation, such as recent pay stubs, bank statements, and employment verification.
- Sign up for your loan. Once your loan processing is complete, you can pay any closing fees and open your new loan account.
How to get a HELOC
If you have at least 15% equity in your home, you may qualify for a HELOC, and lenders will consider your credit, debt-to-income ratio, and other factors. These are the steps to follow to obtain a home equity loan:
- Shop and compare lenders. It is wise to shop with multiple lenders to ensure you get the best deal. Compare loans, interest rates and terms to find the best HELOC for your needs.
- Gather supporting documents. Before you apply, gather your government-issued identification, bank and investment account statements, pay stubs, W-2 forms, and other documents confirming your citizenship, income, and employment status.
- Complete the application. Fortunately, you can usually complete a home equity loan application quickly and easily online. After you submit your application, your loan officer may ask you to submit additional documents or schedule an appraisal of the property.
- Close your loan. On the closing date, you will sign documents, pay closing fees, and activate your HELOC. Processing and closing of your loan can take anywhere from two to six weeks.
Which is better: home equity loan or HELOC?
Decide between a home equity loan and a HELOC it can come down to when you need the money. A home equity loan may be better for you if you need a large amount to cover a major one-time expense, like an unexpected medical bill.
Conversely, a home equity line of credit might be better if you don’t need all the money right away because you only pay interest on the amount you borrow.
Before you decide, crunch the numbers and compare the interest rates, fees and terms of your current loan with a home equity product.
If you’re ready to apply for a home loan, Credible lets you quickly and easily compare mortgage rates to find one that’s right for you.