Should you pay off your mortgage early with a secured home equity line of credit?
Helping you understand shortcuts.
There are tricks a borrower can use to pay off their mortgage faster, paying less interest to the banks.
I'd like to show you an example using "Sue."
Sue currently has an outstanding mortgage balance of $100,000 on her property. The mortgage interest rate is 4%, which costs her approximately $4,000 a year in interest.
According to a recent appraisal, her property is worth $850,000, and therefore, she has a mortgage of 12% of the loan to value.
Since the bank will give her up to 80% of the loan to value, or up to $680,000 (if she qualifies), Sue takes out a line of credit for $100,000 to match what she has outstanding on the first mortgage.
Now her property is mortgaged for $200,000 or 24% of the loan to value.
Instead of using the money she has taken out on a line of credit for purchases or other purposes, Sue pays off her first mortgage of $100,000 with the line of credit. The $200,000 debt is consolidated into just a line of credit of $100,000.
The line of credit's interest rate is Prime plus 1%, so approximately 5%, interest only, which costs her $1,000 extra a year, or $5,000 in interest.
You may be asking yourself, how is Sue getting ahead with paying more money each year in interest payments?
Sue has some savings sitting in a TFSA account and she's contributing to it with each pay cheque and earning minimal return. Here's a better option:
Sue has a TFSA account that has $20,000 in it. Instead of letting the TFSA collect interest at 1%, she puts it towards her “open” line of credit, meaning she can pay it down without penalty whenever she wants. Now she has a balance of $80,000, and she is paying only $3,000 a year towards interest, which is $1,000 less than she was originally paying on her first mortgage balance.
Therefore, Sue is saving over $700 a year because she would have only earned about $200 in her savings account.
As Sue gets paid, instead of putting some of her savings into a TFSA, she deposits it into the line of credit balance which enables her to pay principle faster due to it being calculated using simple, monthly interest instead of being amortized over twenty-five years or longer.
This sounds great but what are the dangers?
The home equity line of credit‘s interest rate can change. The Bank of Canada sets the overnight lending rate, which does fluctuate. Depending on the rates, this can alter how many savings one acquires and how fast they can pay off the line of credit and become mortgage free.
If the line of credit is not used often, one may be charged inactivity fees.
Most people have good intentions when they apply for a home line of credit. However, if someone finds themselves in debt, they could accumulate a balance on the line of credit, making it difficult to pay off. This would make the HELOC very counterproductive to the goal of becoming mortgage-free sooner.
Need mortgage advice? Depending on your unique situation, there are many options to explore to save you money, helping you become debt-free sooner.
Call today for a free consultation (647) 773-4849.
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By: Sarah Colucci
Senior Mortgage Agent, Lic. M14000929