From a mechanical standpoint, using a HELOC to accelerate or pay down your mortgage seems like a good idea. You draw down the HELOC and apply the proceeds to pay down your mortgage balance. Reducing your mortgage balance shortens the length of your loan and saves you money on total interest expense. You can continue to repay and draw down the HELOC as many times as you want and use the proceeds to pay down your mortgage. The faster your pay off your mortgage, the more money you save. While this approach offers the potential for financial benefits, there are several points to consider.
Review How Mortgage Acceleration Works
First, using a HELOC to accelerate your mortgage usually only makes financial sense if the HELOC interest rate is significantly lower than your mortgage rate. This is because when you borrow from a HELOC to accelerate your mortgage, you are effectively replacing one type of loan with another loan.
For example, if you have a $150,000 mortgage balance and use $30,000 in HELOC proceeds to pay down your mortgage you still have $150,000 in total combined debt with the mortgage ($120,000) and the HELOC ($30,000). Unless you lower your average interest rate, because the HELOC rate is lower than your mortgage rate, then you have not gained much financially.
For example, if your mortgage rate is 5% and your HELOC rate is 3.5%, then you benefit from drawing down the HELOC to pay down your mortgage. You can review HELOC rates and loan terms in the table below.
In this scenario, it is important to point out that accelerating a fixed rate mortgage does not lower your required monthly payment so you need to be able to afford your current mortgage payment plus the HELOC payment, so your total debt expense actually increases. Over time, however, you save money in interest expense because you reduce your mortgage term and lower your average cost of debt because the HELOC rate is lower.
Keep in mind that this approach involves risk because the interest rate on a HELOC is subject to change and potentially increase in the future which may diminish the benefits of using it to accelerate your mortgage. For example, the introductory rate on a HELOC rate may be lower than your current mortgage rate for six months or a year but then the rate may be higher for several years after it adjusts, which increases your financing costs.
Plus, if you take out a HELOC you are usually required to pay fees and expenses that you are not required to pay if you accelerate your mortgage directly. In short, if you have the extra money to make a HELOC loan payment, you can use those same funds to overpay your mortgage without the cost, additional monthly payment and potentially higher interest expense that comes with taking out a new loan.
While taking out a HELOC to pay down your mortgage makes sense in certain cases, such as if your mortgage rate is relatively high, you should take into account your total outstanding debt and potential fluctuations in the HELOC interest rate to determine the best approach to accelerate your mortgage. In most cases, overpaying your mortgage directly offers significant financial benefits without the extra cost or risk.