If you have heard about using a Home Equity Line of Credit (HELOC) retire your home loan, there is a strategy that works and will help. It’s called a mortgage accelerator. In this article I will tell you how it works and what are the pros and cons of using it.

  • Accelerators use HELOCs to shorten your loan term
  • You can set up an accelerator for yourself without using a HELOC

HELOCs are very flexible financial instruments, because you can use them much like a checking account. Use them when you need and repay as you are able. That flexibility gives you the opportunity to accelerate your payoff.

Let’s look at how a HELOC works to better understand how you will use it.

How Do HELOCs Work?

HELOCs work differently than conventional loans for one simple reason. Most loans provide a lump sum of money that you spend or put in the bank. You pay interest on the entire balance from the moment you take out the loan. However, a HELOC grants you access to a set amount of money that you can take out as you need it and only pay interest on the amounts that you use.

  • HELOCs grant you access to a revolving account instead of giving you a lump sum of money
  • Your interest is on the amount of money you borrow, not the amount you have access to.
  • You can pay part or all your balance and continue to access the revolving credit

Therefore, you don’t need to borrow the whole amount at once or incur interest on the whole amount until you use it. Now that you understand why HELOCs are more flexible than other loans you may be asking why you would want to take out such a loan.1

Is It Smart?

Whether it is smart to use a HELOC depends on how disciplined you are. The strategy is called a mortgage accelerator. It uses an calculator or spreadsheet to help you pay off your mortgage faster, saving you money on your interest.

Mortgage Accelerator

A mortgage accelerator is a 4-step process to pay down your primary loan faster. The key is using your HELOC to make payments. Then, you use your paycheck to pay your HELOC Here are the steps.

  • Open a HELOC
  • Use the equity line as a checking account
  • Spend less than you earn and pay that amount toward your loan principal
  • Repeat the process until your loan is fully paid off

By putting your paycheck into your HELOC rather than your checking account you are using all your money to service your debt. So, you will be using all your savings to pay off your home loan faster.

The Upside

The upside of this strategy is that it is proven to work. In fact, it is easy to see mathematically how it works. Beyond that, you can get the banks to partner with you to lower your costs.

  • Your bank will set up an accelerator tailored for your situation
  • Your bank will hold you accountable for staying on the program

Your bank has an interest in helping you. They get fees from another loan, and they have a better chance that you will stay committed to paying off your original loan. For you, it is a structured way to pay your primary loan faster and with less interest. Therefore, it is a win-win situation for many people.

The Downside

The main downside to the accelerator is that it is another loan.

  • HELOCs have higher interest rates than your mortgage
  • They have significant transaction costs
  • They have adjustable interest rates
  • You can prepay your home loan without a HELOC

This strategy works. However, the downsides are significant.  Paying interest on another loan is just one downside. If you use this strategy you won’t have any savings. In an emergency you won’t have access to any liquid capital, because all your money is going to retire your first mortgage. Also, if you can’t control your spending you will max out your line of credit and have more debt and not be able to reduce your primary loan. Finally, you may not have enough equity in your home to get a HELOC.

If you are disciplined, you can prepay every month without the structure of an accelerator. All you need to do is send the bank any money you saved during the month.2

HELOC Tax Deductibility

Your HELOC may or may not be tax deductible. It depends on several different factors.

  • If you use your equity line for home improvements it may be tax deductible
  • If you use it for other reasons, such as servicing debt, it is not deductible
  • If you owe more $750,000 after 2018 or $1,000,000 before 2018 then you won’t be able to deduct your loan either

If you are using the money to improve the property, then it is generally tax deductible. However, if you are using the money on other debts, then the loan is not deductible.3

The Bottom Line

Accelerators do work. You can significantly reduce the interest you pay and the time you will need to pay off your debt. Further, banks will be very happy to help you set up these loans and implement this strategy.

Banks, though, have a self-serving interest in selling you this program. They make money on servicing another loan. You will have to pay closing costs and interest for a loan that you don’t need if you are disciplined. Because you can set up a mortgage calculator and a spreadsheet by yourself, you may decide that this strategy is too expensive.

If you have a checking or other revolving account already then you should just use that to pay off your mortgage. Make a budget and put it into a spreadsheet. Then live within the constraints of that budget and use the extra money to pay toward your loan principal.

References

  1. American Financing 
  2. Wall Street Physician
  3. Charles Schwab