Using a line of credit to pay off your mortgage
Do you have a fair amount of home equity in your home and want to do away with those pesky mortgage payments? Well then maybe you are considering getting a HELOC, Home Equity Line Of Credit, and using a line of credit to pay off your mortgage.
A HELOC is a line of credit that you secure against the equity in your home for a lower rate than, say, a personal loan.
Using a line of credit to pay off your mortgage is sometimes most appealing if you have only a little bit left on your mortgage. That way, you can reduce your monthly payments, replacing your mortgage payments with your HELOC payments, and not run up a large loan amount on your HELOC.
What is a HELOC?
To find out what a HELOC is, watch this video where I explain it. Or, read this description from the Homeownering blog.
So if you are looking to use a HELOC to pay off your mortgage, if the interest rate on your mortgage is higher than the rate you will pay on a HELOC, then you could end up paying less money by getting a HELOC and then using that money to pay off your mortgage.
If you’re far along in your mortgage already, then most of your monthly payment is going to paying down your principal instead of just paying interest to the bank. That’s because of the way mortgages amortize – in the beginning of your mortgage you pay more in interest with each payment and then gradually over time you pay more principal and less interest.
HELOCs on the other hand are typically paid back by only paying the interest on the loan. Then, at the end of the draw period, they become rolled into a payment which is amortized, like a mortgage is, with both interest and principal for a period of typically 15 years.
So if you pay a mortgage for which you are making monthly payments that are mostly principal and not interest, and then pay it off with a HELOC where you are paying interest only, it might be wise to make a calculation of which solutions puts more money in your pocket.
Each principal payment you make reduces your loan amount and builds equity in your home, whereas interest payments simply go to the bank and don’t benefit you at all.
Like with any financial decision, the best way to make a decision is by carefully weighing out the costs. How much would you pay if you simply paid your mortgage and how much equity would you build vs. how much would you pay if you got a HELOC to pay back your mortgage and how much equity would you build?
Doing this analysis will result in the answer becoming clear.