Should you take out a HELOC to pay down, or accelerate, your mortgage?
On the surface, 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, which shortens the length of your loan and saves you money on 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 potential benefits, there are several points to consider. As we outline below, it may make more financial sense to overpay your mortgage directly instead of taking out an additional loan.
First, using a HELOC to accelerate your mortgage usually only saves you money if the HELOC interest rate is lower than your mortgage rate. This is because when you borrow from a HELOC to overpay your mortgage, you are effectively replacing one type of loan with another, so your total debt balance remains the same.
For example, if you use $30,000 in HELOC proceeds to pay down a $150,000 mortgage, you still have $150,000 in combined debt outstanding with your mortgage ($120,000) plus the HELOC ($30,000). Unless you reduce the average interest rate across both loans, because the HELOC rate is lower than your mortgage rate, you have not gained much financially.
For example, if your mortgage rate is 5% and the HELOC rate is 3.5%, then you benefit from drawing down the HELOC to pay down your mortgage. If the HELOC rate is higher than you mortgage rate, however, this approach may actually increase your interest expense, which defeats the purpose of overpaying your mortgage.
You can compare HELOC rates and terms in the table below to your current mortgage terms to evaluate your potential savings.
It is also important to point out that accelerating a fixed rate mortgage does not lower your required monthly payment, it only reduces your number of payments. So you need to continue to make your current mortgage payment plus the HELOC payment, which means your total monthly debt expense actually increases, at least in the near term.
Over time you save money in interest expense because you shorten the length of your mortgage, but the savings are not immediate. You may also be able to lower your average cost of debt if the HELOC rate is lower, but again, this is a longer term benefit.
Accelerating a mortgage with a HELOC also involves risk because the interest rate on a HELOC is subject to change and potentially increase in the future, which may reduce your interest savings. 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, you are usually required to pay fees and expenses when you take out a HELOC that you are not required to pay if you accelerate your mortgage directly. In short, if you have the funds to make a HELOC payment, you can use those same funds to overpay your mortgage directly without the extra cost, additional monthly payment and potentially higher interest expense that comes with taking out a new loan.
Use ourMORTGAGE ACCELERATION CALCULATORto determine how much you can save by directly overpaying your 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 rate to determine the best approach. In most cases, accelerating your mortgage directly offers significant financial benefits without the extra cost or risk.
The final points I want to highlight are that you can start and stop overpaying your mortgage at any time over the course of your loan. Additionally, we recommend that you never pay a service to accelerate your mortgage.
Review How Mortgage Acceleration Works
Sources
“My lender offered me a home equity line of credit (HELOC). What is a HELOC?” CFPB. Consumer Financial Protection Bureau, February 24 2017. Web.
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