Paying off your home early with a HELOC

I've a friend who has a friend who is claiming to be using a HELOC to pay off their home in around seven years.

What's a HELOC

A HELOC is an acronym for Home Equity Line Of Credit. The name says it all. It's a line of credit that is secured against the equity you have in your house. The major difference between a HELOC and a traditional mortgage is that the HELOC is revolving, meaning you can take money back out if you would like. You may be asking how getting a line of credit could help you pay off your loan more quickly. As was I. At this point in my career I've heard most of the major investing/buying/selling/refinancing tactics and this one was new to me as of a month ago. (Maybe that should've been a warning sign).

How?

Here's how it works:

1. 1. Get a HELOC for your house that completely pays off your mortgage so you only have the HELOC no secondary mortgage.
2. 2. Put most or all of your cash into paying down the HELOC as much as possible.
3. 3. Going forward put all of your income into the HELOC.
4. 4. Use the HELOC to pay all living expenses.

The concept is simple in thought but gets more complicated in practice. A traditional mortgage will allow you to pay extra but once it's in there you can't get it back out. So if you have an emergency fund that you keep in liquid cash and you decide to drop that into your mortgage and the next month you need to use it you are just out of luck. If you put it in the HELOC you can get it back out to use when necessary. Same would go for putting your income into a HELOC compared to mortgage. The HELOCs that are set up for this purpose also usually make it very simple to withdraw with checks, card, everything like a checking account.

Why?

The only reason this makes any sense is to lower the amount of principle that you are paying interest on. As you probably know you pay interest based on the amount of principle that you have on your mortgage. That's why when you first buy the house you will pay the largest percentage of interest in your payment compared to any other time in the loan.If you have 3% interest on a $100,000 loan your first months interest would be $250. Now let's say you have $50,000 dollars sitting in a checking account that is paying you 0% interest. Why not pay down your loan $50,000 and cut the amount of interest you pay in half. If you have a HELOC you still have the ability to pull that $50,000 back out if you need it and now you are saving 3% interest on $50,000. A dollar saved is a dollar earned.

All sound great right? I thought the same thing but it's not the whole picture. I was trying to decide whether or not to do this with my primary residence and ultimately decided not to do it. I think the people that could actually benefit from this are few and far between, but anyone selling it makes it seem like most people should be doing this to save a bunch of interest and pay off their loan early.

My Situation

I thought this sounded like a good fit for me for a few reasons.

1. 1. I try to keep about $45,000 liquid for my living expenses, emergency fund, and business expenses. At this point all of this money is sitting in a checking account with 0% interest. If I learned anything going through this process is that I need to get that into an investment vehicle that will make me some kind of return while having little risk and keeping its liquidity.
2. 2. As a real estate agent my income is not steady, some months I'll bring in a huge chunk of change and other months I'll literally make nothing.

With those two in mind I thought,

Yeah I can really lower my principle most of the time and have as much of my money as possible going towards paying off the principle and not toward interest.

The Downside

Here are the reasons I decided not to use this method:

1. 1. My intention is not to put all my extra money towards paying off my house. Yes it does cost me 3% interest on my mortgage, but I would rather use that money for other real estate investments that will make me far more than 3% ROI (return on investment). So the only benefit for me would be the $40,000 I initially put in the HELOC to lower the principle. The best case scenario would be this money saving me 3% on the $40,000. A dollar saved is a dollar earned. However this benefit is washed out by reason number two.
2. 2. HELOC interest rates are higher than traditional mortgages and are variable. Right now they seem to be around 5-7% with caps of 18% which would be unbelievable. Even though I would be saving 3% on the $40,000 it would cost me a minimum extra of 2% on the remainder of my principle which would be $114,401.20.
3. 3. I could redeploy about $30,000 of my liquid cash into another liquid investment vehicle such as a high interest savings account, CD, or money market and make around 2% return. Not quite the 3% of my mortgage, but it makes the best case scenario for me as saving 1% on $30,000, 3% on the remaining $10,000, but having to pay 2% or more on $114,401.20.

Let's compare for my situation what would happen if I just keep paying my minimum loan payment until it full amortizes or if I convert it into a thirty year HELOC and deposit $40,000 into it. I used an early payoff calculator here.

*As of this month I only have $154,401.20 in principle. I took $40,000 from that since I would use my emergency fund/personal expenses and deposit it into the heloc.
** I set the interest rate at 6%. To give the HELOC the best chance, we'll say that it stays there for the full 30 year term, but we both know a variable rate is going to vary.

Not good news. Not only would I have paid $51,020 more in interest I would also have to pay for eleven additional months, my monthly payments would increase by $22.24/month, and the $40,000 would no longer be accessible at the end of the HELOC term. I would have to get a new HELOC to access that again, and pay the interest for any I actually used.On the flip side one benefit of the traditional mortgage we didn't add in was the $30,000 of my emergency fund that I could be getting a 2% return on for 29 years and 1 month. In May of 2051 that would be worth $53,662.42. Not a huge gain but still another positive.

Who Does This Benefit?

The only case I could see where this would work is if you had a lot of cash that you needed to keep liquid and everywhere else you could only get a 2% return for it. The extreme case is that I could pay off my loan completely but occasionally need access to that $154,401.20.

I ran a bunch of numbers and if I paid $663.65 for my mortgage payment no matter the minimum I would need to deposit about $70,000 initially for the HELOC to cost me about what the traditional mortgage costs me. To start making it better I would need to invest more initially.

Just Make Extra Payments

You may think I'm ignoring this option but I've also thought of this. You could pay extra to make the HELOC pay off more quickly. You could also do the same with a traditional mortgage. Again the only difference is you can't get your money back with a mortgage. To this I would say you should budget your expenses have an emergency fund worth six months of your expenses. From there decide how much extra you can afford to deposit into your mortgage each month and have your emergency fund to draw from if necessary.

Let's run the numbers for my situation again but the only difference is this time we'll pay a total of $1,327.30 each month (twice my original principle and interest payment).

What do you know this one is a little more nuanced isn't it! You would pay the loan off two years sooner but you would pay another few grand in interest doing it. In this case it's a thirty year term on the HELOC so you would still have 20.5 years that you could draw out the original $40,000 or more while you saved up another emergency fund in that time.Let's not forget by October 2031 that the emergency fund of $30,000 would have grown to $36,271.75 if you didn't deposit it into the HELOC but put it in high interest account. Lastly, you will always run the risk of variable interest with a HELOC.

Should You Use This Method?

This is not the worst thing in the world, far from it. If you are trying to find a place to stick your liquid cash and not aiming to pay the loan off quickly (like myself) it almost certainly is not the right choice. If you you want to pay your loan off as quickly as possible and are able to put down a substantial chunk, that needs to stay liquid for you to maintain your lifestyle, and you are able to pay extra every month it could work. I still think you could get very similar results from just paying extra on your current mortgage without the risk that comes with a HELOC. As always run the numbers for yourself and see where they take you. Then in this case you would need to get the real data from someone providing this type of HELOC loan and again make sure it's going to make sense.

What I've Chose

I'm sticking with my existing mortgage. I always learn something when I take the time to write up these articles. In this case I learned that I shouldn't leave my emergency fund in an account that is not accruing interest. Something is better than nothing. I'v actually got a great opportunity with one of my current car loans(I hate having a car loan BTW, currently working on paying off my wife's loan, and next is my truck). My bank offers a car loan that has the ability to be revolving as well. I never thought I would use it, but it also had a lower interest rate so I went for it. Currently I pay 5% on about $19,000. I can't completely pay the loan off because then it will close the account and I won't be able to draw it back out, but I can pay most of it down and keep the principle super low saving myself 5% interest on about $15,000 which I would not be able to get from a savings account at this point. The rest of the $30,000 I intend to find the highest ROI I can while keeping the risk very low and the money liquid in case I need to use it. If you have a suggestion please let me know!