As long as your mortgage doesn't have a prepayment penalty, you can pay it off at any time, for any reason, with any source of funds that you have available to you. You can pay off your mortgage with a home equity line of credit, even if the HELOC already has a balance, as long as you have enough credit left to cover your mortgage. The real question, though, is whether doing this would be a good idea.
How HELOCs Work
A HELOC is what you get when you put a credit card and a mortgage in a blender and mix them together. Like a credit card, you have a preset limit that you can spend and, like a mortgage, it's secured by your house.
Some lenders allow you to make interest-only payments throughout the draw period, during which the interest accumulates at a fixed rate. In such cases, once the draw period ends, the interest changes from fixed to adjustable, and you must make payments of principal and interest on the amount that you borrowed.
You repay only the amount of the credit line that you actually use plus interest. So if you have a $100,000 line of credit and spend only $40,000, you'll only repay the $40,000 plus interest. HELOC rates are frequently tied to the prime rate, although many of them start out with a very low teaser rate.
HELOC vs. Mortgage Deduction
If you use your HELOC to pay off your mortgage, the interest is almost always fully tax-deductible. Although the Internal Revenue Service caps the interest deduction on your home equity debt at $100,000, a HELOC that you use to pay off your mortgage isn't considered home equity debt. As long as you're paying off a mortgage that you used to buy, build or improve your house, the IRS considers it home acquisition debt. You can write off the interest on the first $1 million of home acquisition debt on your first and second homes.
Using your HELOC to pay off your mortgage can lower your monthly payment, especially if your mortgage has an interest rate that is higher than the rate for your HELOC. During the teaser period, you'll get the benefit of having a very low rate. Once the teaser period ends, you may still have a low rate, but you may also be able to save money by making interest-only payments throughout your HELOC's draw period. You won't have to start paying back principal until your draw period ends and, by that point, you might have already sold your house.
The largest drawback of paying off your mortgage with a HELOC is that, in essence, you aren't really changing anything. You've just substituted a second mortgage for a first mortgage. Also, while using a HELOC may lower your monthly payments, the ability to extend the period of time until you start paying back principal could lead to you paying more interest over time. Finally, since HELOCs usually have adjustable rates, you're exposing yourself to the risk of interest rates adjusting up in the future and making your payments unaffordable.
Steve Lander has been a writer since 1996, with experience in the fields of financial services, real estate and technology. His work has appeared in trade publications such as the "Minnesota Real Estate Journal" and "Minnesota Multi-Housing Association Advocate." Lander holds a Bachelor of Arts in political science from Columbia University.