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Home equity loans and home equity lines of credit (HELOC) are valuable tools that can help you tap into your home’s equity for cash. You can use a home equity loan, or HELOC, to pay for any major expenses, such as a home improvement project.

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In some cases, these home equity financing options can lower your monthly mortgage payment, or even allow you to pay off your mortgage ahead of schedule. Before you begin the process, be sure you understand how to use a home equity loan and HELOC to pay off your mortgage and if it will save you money in the long run.

Makes it easy to get a HELOC through trusted lender partners.

How does HELOC work

Unlike home equity loans, which give you a lump sum of money, HELOCs give you access to a credit line. In this way, HELOCs act 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. CLTV measures the amount of your current mortgage balance and the amount you want to borrow against the value of your property.

HELOCs typically come with variable interest rates and two terms:

  • Draw Duration – During this period, which usually lasts for 10 years, you can access your credit limit as needed and pay only interest on the amount you borrow.
  • repayment period – This period, which lasts for 10 to 20 years, begins after the draw period ends. You cannot access the money during this time and you will have to pay monthly installments which include principal and interest.

How to use a HELOC to pay off your mortgage

Taking out a HELOC to pay off or eliminate your original mortgage is an option, but it’s not something everyone should consider. If you have enough equity and can get a lower interest rate, you can save money, but often the devil is in the details. Consider this example:

Say your home is worth $500,000, and your remaining mortgage balance is $100,000. You took out a mortgage 25 years ago with a 6% interest rate and monthly payments of $2,398.20. if you continue pay off your house Over the next five years, you’ll pay $19,843 in total interest charges over that time frame.

But what happens 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, you have two options for paying off your original mortgage with a HELOC.

Repay HELOC within draw period

With this option, you can still pay off your home in five years, make lower monthly payments, and save on interest. Your monthly principal and interest payment would be $1,841.20, which is about $557 less than you would have earned on your original mortgage. Additionally, you’ll pay $10,427 in interest on your HELOC, less than the $9,416 you would have paid with your original mortgage.

However, remember that HELOCs are variable-rate products, which means that your APR and monthly payment can increase with any interest rate increase. Some lenders now offer fixed rate HELOCwhich may be a better option.

Also, keep in mind, some lenders charge an early prepayment penalty fee, so be sure you understand the terms of any HELOC before implementing this strategy.

Pay the minimum during the draw period

If your income is lower than before, you can opt to make minimum-interest payment only during the draw period. Using the example above, your minimum payment is $332 before climbing to $739 over the 15-year repayment term.

In this case, you create significant space in your budget, reducing your monthly payment to $2,066 during the draw period and $1,659 during your repayment period. The catch, of course, is that you’re paying interest over a much longer period—15 more years to be exact—and you’ll pay over $53,000 in total interest.

Again, these numbers do not take into account any rate increases that may come with a variable-rate HELOC. With this option, you’ll pay more in interest than on your original mortgage, but it can make room in your budget.

Should You Use a HELOC to Pay Off Your Mortgage?

Choosing whether to get a HELOC to pay off your mortgage will depend on your unique financial circumstances. If you have a low balance on your mortgage and can secure 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 might not be able to get a HELOC with an APR low enough to make it worthwhile.

Also, a variable-rate HELOC is generally not a good choice if your income is uneven or irregular. Experiencing a drop in income when interest rates rise can make it difficult to budget for your monthly payments. If you can’t make your payments, you risk losing your home because your home secures your HELOC.

Other things to consider are the upfront costs and annual fees that often come with HELOCs, including:

  • assessment fee
  • Application fee
  • closing costs
  • Annual Fee
  • inactivity fee
  • initial prepayment fee

how to get a home equity loan

A home equity loan may be a better option if you do not need the money over an extended period of time. Home equity loans offer one-time lump sum payments, which may be the money you need to pay for a new roof, install a swimming pool, or any other major home improvement. Follow these steps to find a home equity loan that fits your needs:

  1. Set the amount you want to borrow. Understanding how much money you need to achieve your goal will help you shop around and compare loan offers.
  2. Calculate your home equity. You will need at least 15% to 20% equity in order to qualify for a home equity loan. Subtract your current mortgage balance from the market value of your home to determine how much equity you have.
  3. Shop and compare rates from multiple lenders. Interest rates and repayment terms vary by lender, so it pays to compare several loan offers to find best rate and terms for you.
  4. submit your application. Once you’ve chosen a lender, you’ll want to fill out an application and provide any requested documents, such as recent pay stubs, bank statements and employment verification.
  5. Sign for your loan. Once your loan process is complete, you can pay any closing charges and open your new loan account.

How to get a HELOC

You may qualify for a HELOC if you have at least 15% equity in your home, and lenders will consider your credit, debt-to-income ratio and other factors. Here are the steps to take to get a home equity loan:

  1. Shop and compare lenders. It’s wise to shop around with several lenders to make sure you’re getting the best deal. Compare loans, interest rates and terms to find the HELOC that best suits your needs.
  2. Collect supporting documents. Before applying, gather your government-issued ID, bank and investment account statements, pay stubs, W-2s, and other documents that verify your citizenship status, income, and employment.
  3. Complete the application. Fortunately, you can usually fill out a home equity loan application online quickly and easily. After submitting your application, your loan agent may ask you to send additional documents or determine a property valuation.
  4. close your debt On your closing date, you’ll sign documents, pay the closing fee, and activate your HELOC. It can take two to six weeks to process and close your loan.

Which is Better: Home Equity Loan or HELOC?

decide between a Home Equity Loan and a HELOC You can come down when you need money. A home equity loan may be a better fit for you if you need a large sum of money to cover a large one-time expense, such as an unexpected medical bill.

In contrast, a home equity line of credit may be better if you don’t need all of the money right away because you only pay interest on the amount you borrow.

Before making a decision, run the numbers and compare the interest rates, fees and terms of your current loan versus home equity product.

If you’re ready to apply for a home loan, Credible lets you quickly and easily compare mortgage rates that work for your unique situation.