HELOC to Pay off Mortgage – The Dangers

Using a HELOC to pay off a mortgage is an interesting debate. 

What’s a HELOC?

A HELOC is a home equity line of credit.  If you have equity in your home, you can take out a loan from your bank using that equity as collateral.

Paying off a mortgage with a HELOC is paying off a loan with another loan.

While I’m not so sure paying off a mortgage is the smartest financial move anymore (I used to believe it was), doing it using another loan certainly an idea worth exploring.

I’m going to summarize the issues in a fair and balanced slightly biased way.

So Should I?

My final answer on this is that you should not use a HELOC to pay off a mortgage.  HELOCs are variable rate loans instead of fixed rate like a (good) mortgage.  HELOC interest is not tax-deductible in most cases.  The line of credit can be frozen or reduced by the bank at any time.  Also, even if you are making lower, interest only payments on your HELOC, it eventually will revert to a principal plus interest payment that you may not be ready for.

Of course, there is always the debate of should you payoff a mortgage at all.

Pay off Mortgage with a HELOC – How it’s done

One of the main ways to pay off a mortgage with a HELOC is confusing to someone with as simple a mind as mine.

I will attempt to explain the basics.

  • Each month you use your entire paycheck and apply it towards the mortgage.
  • Then, you use a good credit card (hopefully with points) to handle most of your living expenses throughout the month.  This buys you roughly 45 days of interest-free money.
  • You then use the HELOC at the credit card’s due date to pay it off, and use the same HELOC to make the minimum mortgage payment each months.
  • Next month, you repeat the same process with your whole paycheck.

Analysis

Sounds crazy?  It kind of is.

This method doesn’t actually work unless you have a positive cash flow each month.  Whatever amount above and beyond your paycheck you didn’t spend gets put against the mortgage in a somewhat convoluted way.

This is sometimes called a mortgage accelerator plan.

Banks or other institutions charge people for this method.  I believe it’s somewhat of a scam.

You can set up this method yourself, not that I can see there being much benefit to it.

As far as I can see, this whole plan would work almost exactly the same without the credit card or HELOC

In fact, it would probably work better!

If you spent as frugally as you could all month, and then put the leftover money against principal on the mortgage, you’d have the same result with less complications.

Interest Rate Arbitrage

Another touted benefit of this plan is that you are saving money through arbitrage.

Also, with a HELOC, typically there are no or very little costs, so it’s cheaper than a refinance with closing costs.

In some cases you may have a lower interest rate on your HELOC then your loan.  The logic is, you can benefit and save the difference by using the HELOC. 

Even if the HELOC interest is the same or slightly higher, advocates point out that you are paying simple interest on a HELOC that is calculated based on a daily rate.

Mortgage interest comes from an amortization schedule which front loads interest at the beginning of the loan

Supposedly the different between these two types of interest is also a slight arbitrage opportunity.

I sort of get this, but this isn’t big money.

Personally, I wouldn’t bother.

Interest Only

Another benefit of this method is the ability to pay back interest-only on what you borrow from your HELOC.

While this could be beneficial at first, the interest only period is not forever.

Sometimes after 5 years or so, it converts to a principal plus interest situation at a variable rate

This could be dangerous.  Be ready for a big jump in payment amount when your interest-free period is up!

Pay off Mortgage with a HELOC – A Bad Idea?

pay off mortgage with HELOC
Photo by Jp Valery on Unsplash

Variable vs. Fixed Rates

A majority of homeowners are getting fixed rate mortgages

What you need to realize is, even if you have a better rate with a HELOC, it’s a variable interest rate.  You could end up paying more, a lot more, in the future if interests rates move up.

HELOC Interest is not Tax-Deductible

What?

When I talked about this on social media, a few people came back and said they are deducting their interest.  Their CPA said they could.

Well, you can deduct it if you want, but it’s not legal anymore!

It’s only deductible if the HELOC is used for capital improvements (something that adds value to the house)

So you are swapping a loan where you can deduct interest for one where you can’t.

Hmmm.

HELOCs can be Frozen

pay off mortgage with HELOC
image source

Just ask Elsa.

During the last real estate downturn, several people had their HELOCs frozen, reduced, or just cancelled.

HELOC is a nice option to have, but don’t put yourself in a position where you are depending on it. 

It’s a big credit card that can be taken away on a moment’s notice.

Using a HELOC to pay off a mortgage is not a pay off, it’s a refinance.  You still have a loan, but in a different, and potentially inferior form. 

Went to a non-deductible loan and variable rate

But….

Getting rid of PMI

What about using the HELOC to just get rid of private mortgage insurance (PMI). 

This might be worth it.

You are charged PMI, usually each month, when your loan was made with less than 20% down.

You could try to calculate how much you’d be saving over the course of the loan by putting it all on a spreadsheet and attempting to see if doing so saves you a large amount of money.

The only problem is, you can’t really model this on a spreadsheet.  If it’s variable interest, you can’t be sure how to model out 3 of 5 years into the future.  You also have to calculate the loss of interest rate deduction.

Debt Consolidation with a HELOC

I say this is a no brainer.

Debt consolidation means you use your HELOC to pay off higher interest loans like credit cards or other consumer debt.

Here’s the problem.

Debts like credit cards are not secured debt.  They aren’t tied to anything you own.  If you default on this debt, they typically can’t garnish your wages or take your house.

If you use a HELOC to pay this debt, however, you’ve now turned non-secured debt into secured debt.  If you can’t make the HELOC payments…

They take your house!

Don’t swap non-secured for secured debt.  Not worth the savings.

There Must Be a Better Way

There is a better way to pay off your mortgage early.

Stop getting tricky with HELOCs and credit cards. 

Spend less than you make and pay off your mortgage with the difference.

Seek to earn more by doing these such as getting a raise, switching jobs, and getting a side-hustle.

Read my post and/or watch my video on 5 Secrets to Paying off your Mortgage Fast

Have you used a HELOC? 

What did you do with it?

What is your take on the paying off mortgage with HELOC debate?

Comment below! 

Yes, I want you to!

Rich on Money

12 thoughts on “HELOC to Pay off Mortgage – The Dangers”

  1. I used the HELOC method and paid off my house in a couple years VS the 10 that was left on the mortgage. The key is having a lower daily balance with using the HELOC like a checking account. I didn’t do the credit card part and it made no difference. This is not a scam but I agree it is best to do it on your own not with “help”. Also, if you are using a HELOC to payoff your mortgage the chance it is frozen is close to 0. Banks will freeze a HELOC when the property it is attached to becomes upside down in value but if you are using the HELOC to payoff the loan you are building equity fast, so the bank will have no reason to do this. With interest rates on savings as low as they are it is better to keep your money in the HELOC avoiding interest charges which is equivalent to getting that rate on the money. If you have a large gap between your expenses and your income this makes tons of sense. Paying extra payments on your mortgage is a waste of time since there is no flexibility if you need the money back, a HELOC allows you to remove that extra payment by writing yourself a check. Just my 2 cents.

    Reply
    • I’ll admit the situations where it would be frozen and quite rare.

      If you have a large gap between your expenses and your income, I imagine you would have paid off the loan just the same without a HELOC. Now if you are saying it’s good to have the HELOC for emergencies, that’s one argument. That doesn’t mean you need the HELOC to pay off your loan faster.

      Reply
  2. I have been researching the HELOC payoff method. I’ve been paying on my mortgage for ten years now using the standard approach, so the HELOC method does not benefit me very much financially. I could plow my additional free cash flow into the mortgage. However, once there it is locked and cannot be used again if needed. The HELOC method will enable me to be able to throw every dollar at the HELOC/Mortgage each month because I still have access to it if needed. Essentially the ability to have my cake and eat it too.

    Reply
    • I guess, but sometimes not having access to your equity is a good thing IMHO. Imagine if you would have been highly leveraged going into this current crisis. I sleep very well at night with almost no leverage. No matter how bad things get, I’m fine. I’m better than fine. That’s priceless.

      Reply
  3. Thank you Rich, I also favor a conservative approach like yours. Just wanted to clarify – when you wrote that its OK to use HELOC to avoid PMI, I understand this as, it is OK to use HELOC to make your 20-25% downpayment for the loan. And then work hard to pay off your HELOC and then the mortgage? Is that right?

    Reply
  4. Rich, I owe $45,000 0n a home worth $200,000 with monthly payments of $750 @ 6% interest. Can I get a HELOC loan for say $80,000 and pay off my mortgage and have $35,000 for home improvement etc. With lower house payments? Credit score is 733
    Thanks

    Reply
    • Of course you can. If you get a loan to payoff a loan, have you really paid it off? Not really. You’ve just changed the nature of your loan.

      Up to you. I don’t do it, but who listens to me?

      Reply
  5. Not having access to your equity can be a good thing? Boy, you must not trust yourself at all. Maybe you should just put your money into long term cd’s, then. There’s a hell of a strategy. Let me put it this way… you can always borrow when you don’t need to. But wind up in a position where you really need it (like so many do today thanks to COVID 19), and you may find there are no lenders to help you. Maintaining access to your home’s equity is one of the most prudent things you can do.

    Reply
  6. We’ve been toying with the idea of using a HELOC to buy ( outright) a rental property in 30-60k range. I’d love to hear your thoughts. A few more details; we owe 82k on our home, currently valued at 425k. Crazy market here!4 ish years left until we have it paid off! We have a one year emergency fund, and max our 401K, HSA, and two IRA contributions. While those are all good things , it doesn’t leave much leftover cash to save for a rental home. So, buy rental house outright with HELOC, save portion of rent for expenses and the remaining goes right to the HELOC until it’s paid in full. Rent would be approximately 650-850 depending.

    Reply
    • I don’t like using a heloc for that. Save up the money to buy an investment property. if you don’t like my answer, there are 100’s of real estate gurus who would disagree with me.

      Reply

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