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You may be familiar with the home equity line of credit (HELOC) method of early mortgage repayment. Over time, this novel concept has gained more acceptance in some personal finance communities. Although the concept is straightforward in theory, you must learn a lot about the approach before committing to using it to pay off your mortgage.
We’ll explain the HELOC payoff strategy so you can understand what you’re getting into. You must weigh the advantages and disadvantages up front because of the rising interest rates.
What’s the HELOC Payoff Strategy?
To understand the HELOC strategy for early mortgage repayment, we must first define the term. Essentially a second mortgage on your home, a HELOC is a revolving line of credit. With a HELOC, you can frequently borrow up to 80% of the value of your home while using the equity in your home as collateral. The equity is the amount that is left over after paying off your mortgage compared to the home’s current market value.
If your home has appreciated in value, you can use this HELOC similarly to a credit card because you can choose how much of the balance you want to spend during the draw period up to the allotted limit. With a HELOC, you only have to pay back what you use.
Because it resembles a credit card, a HELOC differs from a home equity loan, which is a lump sum with a fixed interest rate.
You should be aware of the following two HELOC periods:
You may want to think about the alternative and unorthodox HELOC payoff strategy. You can use your HELOC however you’d like, so you can use it to pay off the balance on your mortgage. Because you can lower your monthly payments while lowering the total amount of interest paid on your loan, many people believe in it.
The objective is for the homeowner to be accepted for a HELOC with a credit limit equal to the outstanding mortgage balance. The goal is to obtain a credit limit of $100,000 so that you can use this money to pay off your entire mortgage if you still owe your mortgage $100,000. After that, you would only pay interest until the payback period. The HELOC strategy makes sense if you could obtain a lower interest rate with your HELOC than with your fixed mortgage.
Since you can lower your interest rate without having to deal with the closing costs typically associated with refinancing your home mortgage, this method is really just another way to refinance.
What Are the Advantages of the HELOC Strategy?
The flexibility that comes with a HELOC is its biggest advantage because you can access money that you can use however you see fit. You could, for instance, use a HELOC to pay off your mortgage, settle some other debt, or even to renovate your house. Some people have renovated their homes using HELOCs in order to sell them for more money.
Low To No Closing Costs and Lower Interest Rates
You don’t have to go through the customary refinancing process that you would have to with your primary mortgage when you obtain a HELOC. Some lenders also offer no-closing-cost HELOCs.
In addition, depending on when you locked in your home loan, you might be able to use a HELOC to make payments at a much lower interest rate.
What Are the Disadvantages?
Although the HELOC payoff strategy may appear straightforward, there are additional aspects of this theory to take into account.
Variable Interest Rates Could Go Up
You might find yourself in a situation where your HELOC costs you more than your original mortgage because it has a variable rate while your home mortgage has a fixed rate. Considering that variable rates are currently rising, you might find yourself paying more in interest for your HELOC than you anticipated.
The unfortunate truth is that many people cannot be trusted with access to what is essentially a high limit credit card. You would use the HELOC strategy to pay off your mortgage early in an ideal world. But in reality, if you’re tempted to make a purchase, you could use this as a different credit card for regular purchases.
Your Life Situation Could Change
It will be difficult to maintain the HELOC strategy during times of financial stress, in addition to the discipline it will take to manage its complexity. Everything can happen to your financial situation, as we’ve seen in recent economic uncertainty and the potential for a recession.
You’re Replacing One Form of Debt With Another
Any strategy that includes debt is playing with fire. This is due to the fact that as you grow accustomed to using debt, the likelihood that you will abuse it increases. To avoid getting into an even worse financial situation during the several years it will take to pay off the mortgage, extreme discipline will be required.
Paying off your debt with money from your income or other assets is the only way to truly become debt-free. Using debt to settle other debts could end up having unexpected consequences.
Take this, for example:
Your HELOC strategy reduces your $200,000 mortgage to $100,000 after five years. But because of macroeconomic factors, you now owe $100,000 on a HELOC at a higher variable rate than your prior fixed rate. With the exception of a small amount of money saved on interest at points, you won’t really benefit much.
We must also remind you that, given the current environment of rising interest rates, you might prefer to concentrate on making additional mortgage payments rather than dealing with the hassle of applying for a HELOC.
Consider the scenario where you lack confidence in the HELOC plan for early mortgage repayment. What can you do? Here are a few alternative options.
This will not only shorten the length of your mortgage, but it will also give you total control over the procedure as it progresses. Depending on your current financial situation, you can make higher or lower additional payments.
Keep in mind that paying off a mortgage is a lengthy process that takes years. Because of this, the approach you select must be compatible with both your personality and your financial situation. It doesn’t necessarily follow that you and your family should follow a financial strategy just because it worked for someone else online.
The Final Word on the HELOC Strategy
Whether or not you should employ this tactic will depend on your unique circumstances and your level of comfort. If getting out of debt is your goal, there are several ways you can pay off your mortgage early. Although the HELOC payoff strategy appears to be popular right now, it is not your only choice.
Be sure you understand what you’re signing up for before using the HELOC strategy to pay off your mortgage early. We cannot ignore the state of the economy at the moment, which includes skyrocketing inflation and rising interest rates. You might find yourself in a situation where a variable interest rate that is constantly fluctuating has taken the place of a fixed mortgage payment as interest rates are rising quickly.
Since 2009, Kevin Mercadante has chronicled his transformation into a contract/self-employed/worker accountant/blogger/freelance blog writer on OutofYourRut from a washed-up mortgage loan officer emerging from the Financial Meltdown. com.
© 2021 DoughRoller. All rights reserved.
Is it a good idea to pay off mortgage with HELOC?
You could save money and possibly pay off your mortgage sooner because HELOCs occasionally have lower interest rates than mortgages. Refinancing your first mortgage with a HELOC may still be the best option for you even if the rates are comparable.
What is the HELOC strategy to pay off mortgage?
Using a HELOC to Pay Off a Mortgage Once the HELOC has been approved, the homeowner can use the credit limit to pay off the mortgage. The homeowner then pays the HELOC rather than the mortgage with the payments. Due to lower payments, this can increase cash flow while reducing overall interest costs.
Can I take equity out of my house to pay off mortgage?
Homeowners with positive equity are able to take advantage of their wealth in a variety of ways. Utilizing a home equity loan to partially or fully pay off your mortgage is one way to access this equity.
How does the HELOC strategy work?
HELOCs have a draw period, which is typically 10 years long, and a repayment period, which is typically up to 20 years long. You are permitted to borrow all of the funds during the draw period. You don’t pay back the loan’s principal with payments you make during the draw period because they are “interest only.”