How a HELOC can pay down or replace your mortgage

A HELOC (home equity line of credit) lets you borrow against the equity you have built in your home, then use that money to pay off your mortgage balance. The basic mechanics are straightforward: you draw funds from the HELOC, send that money to your mortgage lender to reduce what you owe, and then repay the HELOC on its own schedule. This works because a HELOC typically carries a lower interest rate than other forms of borrowing, and the interest may be tax-deductible if you use the funds for home improvement.

The appeal is real but comes with a tradeoff. You are converting a fixed 30-year mortgage into a variable-rate line of credit, which means your monthly payment can rise if interest rates climb. You also replace a loan with a set payoff date with one that has a draw period (usually 5 to 10 years when you can borrow) followed by a repayment period (usually 10 to 20 years when you cannot borrow anymore, only repay). If you do not have a plan to pay down the HELOC faster than the mortgage would have been paid, you may end up owing money longer, not shorter.

Key Takeaways

  • A HELOC draws money against your home's equity at a variable interest rate, which can be lower than your mortgage rate but will fluctuate with market conditions.
  • You must have built equity in your home — typically at least 15 to 20 percent — before a lender will open a HELOC.
  • The HELOC interest rate is usually prime rate plus a margin set by your lender, so your payment changes when the Federal Reserve raises or lowers rates.
  • Paying off a mortgage with a HELOC only saves money if the HELOC rate stays lower than your mortgage rate and you pay down the HELOC faster than you would have paid the mortgage.
  • If you stop making payments on a HELOC, the lender can foreclose on your home, just as with a mortgage.

What equity you need before a lender will open a HELOC

Lenders typically require you to have at least 15 to 20 percent equity in your home before they will open a HELOC. Equity is the difference between what your home is worth and what you still owe on your mortgage. If your home is worth $300,000 and you owe $240,000 on your mortgage, you have $60,000 in equity — 20 percent of the home's value.

Most lenders will let you borrow up to 80 or 85 percent of your home's total value, minus what you still owe on your first mortgage. Using the example above, if your home is worth $300,000 and you can borrow up to 85 percent, you could borrow up to $255,000 total. Subtract the $240,000 you owe on your mortgage, and you have $15,000 available through a HELOC. Some lenders are more aggressive and will lend up to 90 percent of home value, but that leaves you with less cushion if your home's value drops.

How HELOC interest rates work and why they change

A HELOC interest rate is almost always variable, meaning it moves up and down based on a benchmark rate set by the Federal Reserve. Your rate is calculated as that benchmark (called the prime rate) plus a margin — typically 0.5 to 2 percentage points — that your lender adds. When the Federal Reserve raises rates, the prime rate goes up, and your HELOC rate goes up with it. When the Fed cuts rates, your HELOC rate falls.

This is different from a fixed-rate mortgage, where your rate stays the same for the entire 30-year loan. With a HELOC, your monthly payment can jump significantly if rates rise. For example, if you borrow $100,000 on a HELOC at 7 percent interest, your monthly interest cost is about $583. If rates rise to 9 percent, that same $100,000 now costs you about $750 per month — an increase of $167. Over a year, that is an extra $2,000 in payments.

Some HELOCs offer a fixed-rate option for part or all of the borrowed amount, but that fixed rate is usually higher than the variable rate at the time you lock it in. You are paying extra for the certainty that your payment will not change.

The math: when a HELOC actually saves you money on a mortgage

Using a HELOC to pay off a mortgage only saves you money if two things happen: the HELOC rate stays lower than your mortgage rate, and you pay down the HELOC balance faster than you would have paid down the mortgage.

Suppose you have a $200,000 mortgage at 6.5 percent with 25 years left. Your monthly payment is about $1,300. You open a HELOC at 7 percent (the prime rate plus margin) and use it to pay off the mortgage. Now you owe $200,000 to the HELOC instead. If you make the same $1,300 monthly payment, you are paying slightly more in interest because the HELOC rate is higher. You have made the situation worse, not better.

The strategy only works if the HELOC rate is lower than your mortgage rate and you commit to paying more than the minimum. If your HELOC rate is 5.5 percent and your mortgage is 6.5 percent, and you pay $1,500 per month instead of $1,300, you save money on interest and pay off the debt faster. But this requires discipline: you must treat the HELOC payment as non-negotiable, even when rates rise and the payment becomes uncomfortable.

The draw period and repayment period: how the timeline works

A HELOC has two phases. During the draw period — usually 5 to 10 years — you can borrow money, repay it, and borrow again, like a credit card. You are only required to pay interest on the amount you have actually borrowed. Once the draw period ends, the HELOC enters the repayment period, which typically lasts 10 to 20 years. During repayment, you cannot borrow anymore; you can only pay down the balance.

This matters because many people use a HELOC to pay off a mortgage, then stop making large payments during the draw period, assuming they will pay it down later. When the repayment period arrives, they suddenly face a much larger monthly payment because the lender now requires principal repayment, not just interest. If you borrowed $150,000 and the repayment period is 15 years, your minimum payment jumps significantly. You may find yourself unable to afford it.

Plan for the repayment period before you open the HELOC. Calculate what your payment will be once you can no longer borrow, and make sure you can sustain it. Many people use a HELOC to pay off a mortgage only to refinance the HELOC into a new mortgage when the repayment period arrives — which defeats the purpose of the strategy.

Risk: your home is collateral for the HELOC

A HELOC is a secured loan, meaning your home is collateral. If you stop making payments on the HELOC, the lender can foreclose and sell your home to recover what you owe, just as a mortgage lender can. This is a critical difference from an unsecured loan like a credit card or personal loan, where the lender cannot take your home if you default.

This risk is often overlooked because people think of a HELOC as a flexible borrowing tool, not a second mortgage. But legally and practically, it is a second lien on your home. If you face a job loss, medical emergency, or other hardship and cannot pay both your mortgage and your HELOC, you are at risk of losing your home. The HELOC lender has a claim on your home's equity, and they will enforce it.

Additionally, if your home's value drops significantly, you may end up owing more than the home is worth — a situation called being "underwater." If you have a mortgage and a HELOC, and the home value falls, you could owe money to both lenders with no way to recover the difference by selling.

Alternatives to using a HELOC for mortgage payoff

If your mortgage rate is higher than current rates, you have other options that may be simpler. A cash-out refinance replaces your entire mortgage with a new one at a lower rate and pulls out equity as cash, which you can use to pay off the old mortgage. This consolidates everything into one loan and one payment. The downside is that you pay closing costs (typically 2 to 5 percent of the loan amount) and you restart the 30-year clock, so you may pay more interest over time even at a lower rate.

A home equity loan (different from a HELOC) is a fixed-rate, fixed-payment loan secured by your home's equity. You borrow a lump sum, receive it all at once, and repay it over a set term — usually 5 to 15 years. This gives you the certainty of a fixed payment and a known payoff date, but you cannot borrow more once the loan is closed. A home equity loan is simpler than a HELOC if you know exactly how much you need and want a predictable payment.

If your mortgage rate is already competitive and you straightforward want to pay it off faster, the simplest strategy is to make extra payments toward principal on your existing mortgage. There is no process, no closing costs, and no risk of your rate changing. You sacrifice the potential for a lower rate, but you avoid the complexity and risk of a HELOC.

Frequently Asked Questions

Can I use a HELOC to pay off my mortgage if I still owe a lot?

Yes, as long as you have enough equity. If you owe $200,000 on a $300,000 home, you have $100,000 in equity. Most lenders will let you borrow 80 to 85 percent of the home's value ($240,000 to $255,000), minus what you owe on the first mortgage. In this case, you could borrow up to $40,000 to $55,000 through a HELOC — enough to pay down part of the mortgage, but not all of it.

What happens to my HELOC payment if interest rates go up?

Your payment will increase. A HELOC rate is tied to the prime rate, which moves with Federal Reserve decisions. If you borrow $100,000 at 7 percent and rates rise to 9 percent, your monthly interest cost jumps from about $583 to $750. This can happen multiple times over the life of the HELOC, so budget for the possibility that your payment could rise by hundreds of dollars per month.

What if I cannot afford the HELOC payment when the repayment period starts?

Many people refinance the HELOC into a new mortgage or home equity loan to extend the payoff period and lower the monthly payment. This is common but means you have not actually paid off the original mortgage — you have just converted it into a different form of debt. Plan ahead by calculating what the repayment-period payment will be and making sure you can afford it before you open the HELOC.

Is the interest on a HELOC tax-deductible?

HELOC interest may be tax-deductible if you use the borrowed money for home improvement or other may have access to purposes, but the rules are complex and depend on your specific situation. The interest is not deductible if you use the money for personal expenses like a vacation or car purchase. Consult a tax professional before assuming your HELOC interest is deductible.

What if my home's value drops after I open a HELOC?

Your HELOC balance does not change, but your available borrowing may shrink. If your home was worth $300,000 when you opened the HELOC and is now worth $250,000, lenders may reduce your credit limit or freeze your account. In extreme cases, you could owe more than the home is worth, leaving you unable to sell without bringing cash to closing.