An Interesting Use for a Home Equity Line of Credit
One of the more intriguing ideas I have seen recently is a rather unique use for your home equity line of credit (HELOC). The HELOC is a second home mortgage that works a revolving line of credit. Basically, it’s like a big credit card, without the plastic. You can continue to borrow money from your home equity line of credit, as long as you are paying down the balance.
This post isn’t about how you can get out of debt with a HELOC, per se. Rather it’s about how you can use this second home mortgage to pay off your home loan faster. But be forewarned: this takes discipline. If you aren’t careful, you end up in debt and could get into troubled. So, you need to be sure that you can control your spending and use this system to your financial advantage.
The home equity line of credit to pay for everything
Here’s how it works. You take out the HELOC for your home. This second home mortgage can be used to replace your original home loan. Get it for 30 years, and try to get it at a fixed rate (difficult in the current climate). Next, put your entire paycheck (minus your savings and charitable contributions, of course) into “paying off” your home equity line of credit. This will cover your minimum payments and put more toward the principal. Buy everything you need and put your bills on credit cards (preferably with good rewards programs). Each month, use your home equity line of credit to pay off your credit cards in full.
As long as you are living within your means, what you put into the HELOC will more than cover your expenses. But you have to live on 70% to 75% of your income (because you should be putting at least 10% into savings, and giving something to charity if you wish) to make this process work.
Advantages to this HELOC system
If you do this, your second home mortgage will be paid off well before the 30 years, and you can keep using the equity in your home, even after the mortgage has been paid off. You will pay much less in mortgage interest because you have paid it off so quickly. But that’s not all. In many cases the mortgage interest you do pay on a home equity line of credit is tax deductible. And don’t forget all the free rewards you get for putting your expenses on the credit cards and paying them off each month.
There is an up front cost to this, though. In order to structure everything correctly, and to get your cash flow moving in the right direction, you will need to consult with an accountant. It can cost between $1,500 and $3,000 to set this up. But the savings down the road are worth it.
Tags: home equity loan, HELOC, second home mortgage, home equity second mortgage,
mortgage interest rate, debt consolidation home equity, home equity line of credit
August 31st, 2007 at 8:54 am
On the surface this looks like a reasonable alternative. But there are pitfalls many could fall into.
First off, you will never be able to get a fixed rate line of credit. They simply don’t exist. (Many banks offer rate lock features that are fixed, but they are closed end loans within the line of credit with no draw feature) A bank will never lock in a fixed rate and give you the ability to redraw monies. Thats why a fixed rate credit card is just a myth. You may think you have a fixed rate card, but the terms and conditions allow CC companies to change the rate any time with due notice. (this excludes promos or teaser rates). This is a hedging strategy used by banks since they never know what the cost of funds will be in the future. Think about it, why would a bank lend you money at 6% when in 5 years it may cost them 7%?
Also with this HELOC strategy, you are basically having to forego all savings in lieu of a more rapid mortgage payoff. Yes, you can access cash through your line of credit, but there is something to be said for liquidity in the form of savings.
Also some lenders may charge closing costs and prepayment penalties which further dilute the savings. And if you live in a mortgage tax state like New York, FL, VA with high mortgage taxes, that is another bite.
For my money, I would steer away from it. The average homeowner refinances every 55 months and moves about every 6 years. You are better off keeping credit card and auto loan debt to 0 and building your wealth through structured savings and investments. Let dollar cost averaging help you save for college and retirement. There are no quick wins to wealth building.
Make 50% of your mortgage payment every 2 weeks and you knock 7 years off your 30 year mortgage, keep your fixed rate and manage cash flow better.
I would be glad to answer questions or help folks who need more info, just email me at vancini@sbcglobal.net (I am not a mortgage broker, but a recently freed lending executive who is glad to help others.)
August 31st, 2007 at 2:30 pm
Oh, I agree that this wouldn’t work for everyone. I mention above that one has to be on a strict budget and put money into savings as well as do this plan. I’m not doing it. It is merely one idea that I have seen several of my very disciplined associates pull off quite beautifully.
Thanks for your comment! Many of your points are quite valid, and I especially like the bi-weekly payment idea.