Pros and cons of HELOCs
HELOCs are not without risk, especially given their unique structure, but they can be useful when used carefully. For example, while you can pay off a student loan, personal loan, or credit card debt, you won’t be able to deduct HELOC interest from your taxes. On the other hand, if you use a HELOC to either improve your home or to pay off your mortgage balance, you can deduct that interest.
However, with interest rates still so low, it could potentially benefit you to pay off those higher-interest-rate loans using your HELOC long before you attack your lower interest rate mortgage, since you’re still able to deduct the mortgage interest on your primary mortgage.
How you use your HELOC should ultimately come down to what makes the most financial sense when the whole picture is considered, from mortgage interest to allowable deductions.
What happens when you pay off your mortgage with a HELOC?
Paying off your mortgage with a HELOC can be a point of concern for some borrowers, since HELOCs are generally understood to be second mortgages, holding secondary lien positions. If you pay your first mortgage off with a second mortgage, what do you even have?
Well, in that situation, you have a HELOC that’s in your first lien position. Your HELOC will take the priority of the original home loan. Lien position is all about who gets paid off first if you default, so if there’s no first mortgage left, everybody gets a promotion. Your second mortgage becomes your first, and if you have a third, it becomes your new second.
If you were to take out a new mortgage for some reason after paying off your original mortgage with a HELOC, your lender should be able to explain where the new loan falls in priority. But for you, that’s not a big deal. If you default on your third mortgage, you’re still at risk of foreclosure, so it’s all really effectively the same story from where you’re sitting.
The Millionacres bottom line
Since we’ve established that you can pay off a mortgage with a HELOC, the bigger question is whether you should. As stated above, if a HELOC is used to improve your home or pay it off, you can deduct the interest -- up to $750,000 of mortgage debt.
In many areas, $750,000 will make a big difference to how your property looks and functions, but in today’s market, homeowners are also seeing huge increases in their home's equity simply by continuing to keep it standing and reasonably clean, so updating and upgrading isn’t an absolute necessity.
If you intend to hold on to your home, the best money may be on building an accessory dwelling unit, if your local zoning will permit it. If not, adding an extra suite with its own entry can still allow you to roll your own house hack out of what was once a plain, single-family property. Again, this is highly dependent on the local market and your current loan terms, but adding some income-generating cash flow to your home could not only increase the value of the property but give you a significant return beyond simply lowering or eliminating your monthly payment directly.