There’s a new theory out there and it includes paying your mortgage off early using a home equity line of credit, otherwise known as a HELOC. Many have claimed success using a HELOC to pay off their mortgage in a record amount of time.
Does it work?
When reviewing the technical aspects of this theory, it appears it’s an exceptional way to become mortgage-free in a record amount of time and save money but when putting it to practical use; it seems to be a far-fetched concept that is too good to be true for many.
But let’s look at the strategy in more detail and consider the likelihood of it succeeding.
First, here are some things that must be in place in order for this strategy to be successful:
Here’s an example of this method in action.
Let’s say you have a $300,000 mortgage and a home equity loan secured against your house, and your next paycheque is approximately $5,000. One month, you decide to apply your entire paycheque to the mortgage. Of course, this would immediately lower your mortgage balance to $295,000. Then, let’s say, that month your non-housing expenses amounted to $2,000 using your credit card.
So, you decide to pay $1,000 using your home equity line of credit. You also decide to pay your credit card balances with your home equity line as well. At the end of the month, you will owe $3,000 on the home equity line of credit and $295,000 on your mortgage BUT your credit card now has a zero balance.
Then, the next month comes along and your $5,000 paycheque gets applied to the $1,000 you used from your home equity line of credit and the $2,000 you used for living expenses, also on the line of credit. The remaining $2,000 reduces the Home Equity Line balance to $1,000.
Now, let’s look at what happens in the third month. Your $5,000 paycheque arrives and so you use $1,000 to pay off the rest of the HELOC, $2,000 for your living expenses, and $1,000 for the mortgage.
This would leave you with an extra $1,000 that you could carry over into the next month. Of course, in the next month, you could repeat the original cycle and take your $5,000 cheque and lower your mortgage to $290,000.
This strategy basically allows you to pay off your mortgage 10-15 years earlier than expected because you would make an extra annual mortgage prepayment of $20,000 or more.
Realistically, this strategy is too complex to be a practical way to pay off your mortgage faster. After all, living expenses come up when they come up and there is no way to predict how much you will need every single month.
Using this method to pay off your mortgage also means you're constantly using both secured (mortgage) debt and unsecured (credit cards) debt to manage your finances which means there isn’t much room for savings and you could risk paying higher interest on your HELOC since HELOC rates are higher than closed mortgage interest rates.
The other problem is most people do not actually have this much discipline, but if you do, kudos to you (you would really need to have complete control of your personal finances).
In reality, because life is unpredictable, it can become very difficult to keep this monthly routine going year after year. Eventually, most people would fall off this cycle and live within their paycheque. Also, if someone loses their job or if some unforeseen situation comes up like the requirement to complete home improvements, it may throw off the entire plan.
The other risk is in constantly using credit cards because if you suddenly can’t pay off their balances, it ends with unnecessarily racking up high-interest credit card debt that can become impossible to pay off. In fact, most people end up refinancing to complete a debt consolidation just to get away from the infamous credit card trap.
Also, playing with debt in this way is ultimately like playing with fire and one never knows when and if they will get burned. And, of course, there are better (and safer) ways to pay your mortgage off sooner.
Refinance your mortgage to a lower rate.
You can accomplish paying your mortgage sooner through refinancing at a lower rate (provided you have equity in your home), consolidating higher-interest debt, using additional cash flow to prepay your mortgage, which ultimately reduces your amortization period making you mortgage-free sooner.
You can also make regular principal payments that range from $100 (minimum prepayment required) to 25% of the original principal balance each year without a penalty.
Another way to reduce your amortization is to change your monthly mortgage payments to bi-weekly, accelerated payments. By shortening your payment frequency to 26 payments, one extra mortgage payment a year goes towards reducing the principal balance and is free from any interest.
You can always try using a line of credit HELOC to prepay your mortgage in a record amount of time but if it doesn’t work, make sure you exercise all the other ways to pay your mortgage off sooner.
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Sarah A. Colucci, Mortgage Agent Lic. M14000929
Mortgage Edge, Broker 10680
Direct: (647) 773-4849
Sarah Colucci is an independent mortgage professional who works with a variety of borrowers and mortgage lenders in Ontario. It is her job to assess a borrower's current financial situation and place them with the best lender that can complement both their short- and long-term goals in real estate and in life.
Sarah works to produce solutions that her clients can be proud of. She has extensive experience in real estate and mortgage origination and further specializes in a variety of mortgage products for the many unique borrowers that exist and who often find they don’t fit into rigid banking policies.
Sarah promises to be truthful and give honest assessments based on her experience and knowledge, and acts with integrity and honour, always doing what she believes is the right thing to do.
By: Sarah Colucci
Senior Mortgage Agent, Lic. M14000929