Debt is not evil. Personal and credit loans in Canada, to name a few, are simply tools to achieve your financial goals over the short or long term. All forms of credit do not provide free money, and some can hurt your pocket worse than others. They can make your life miserable only if you do not know how to use them right.
One of the smartest ways to use debt to maximum effect is utilizing one to pay another off. In light of recent news about seniors carrying an unpaid mortgage when they are supposed to enjoy their retirement, indebted homeowners should consider applying for a home equity line of credit (HELOC) to zero out the remaining balance of their decades-old mortgage.
A HELOC is a revolving line of credit that lets you borrow the difference between 80% of what your property’s current value is and what you owe on it. A HELOC lender will not let you tap 100% of your available home equity, for having the green light to do so may put you in graver financial distress in the future.
Make no mistake about it; using a HELOC to pay off your mortgage will not make you free and clear. A HELOC can be considered a second mortgage because you are borrowing against your property whenever you access funds through this revolving line of credit.
If you will not be mortgage-free if you pay off your mortgage through a HELOC, what is the sense of doing this, then? There are instances when this strategy is logical. Below are the scenarios where you should consider taking this route.
If You Want More Payment Flexibility
Funds obtained through HELOC are subject to interest, but you are not required to pay both the interest and principal every month. You have the option to settle at least the interest portion of the bill to keep your payments to a minimum.
If You Do Not Have to Face a Prepayment Penalty
Paying off your mortgage with HELOC money makes a ton of sense if your lender does not impose a prepayment penalty, prepayment charge, or breakage cost. Many mortgage lenders disincentivize such practice to preserve the total profit they could rake in when the loan matures properly.
If your lender does charge a prepayment penalty, you may have to pay thousands of dollars on top of the outstanding principal. Naturally, the extra charge increases the cost of taking out a HELOC. To pay off your mortgage ahead of schedule and avoid any penalty at the same time, maximize the prepayment privilege your lender may allow.
This mortgage feature lets you increase your normal monthly payments to reduce the principal more quickly. Use the HELOC to access enough cash to beef up your mortgage payments and shorten the term of your loan effectively.
If You Can Handle Greater Interest in the Future
The interest rates of HELOCs are not fixed; they move as the prime rate goes down or up. Although a higher interest rate adjustment is bad news, it should not worry you too much since you can put off principal payments (if necessary) to avoid ruining your budget.
Like other financial products, a HELOC is prone to misuse and abuse. Yes, it can be instrumental in zeroing out your mortgage balance, but it can work against you if you do not fully understand its potential risks.