Monday, January 28, 2008

How I paid off my Home with a Home Equity Line of Credit!

I used a HELOC to pay off my home mortgage! How convoluted is that? I used the equity in my home to qualify for a loan. I then used that loan money to pay off the remaining mortgage amount.

The whole thing started when my mortgage lender, Washington Mutual, called me to re-finance. Their new rates were slightly lower than my loan. However, I already had plans to pay it off early and when I ran the numbers it just was not worth the drive to their office to do the paperwork. The loan officer on the other end of the phone was in disbelief. She said over and over that “It won’t cost you anything, it’s a free refinance!” I held my ground, I wanted a better rate or nothing at all.

The next day, the loan officer called back. She said she had just the deal for me. Now, I was really suspicious. She suggested that I pay off my mortgage with a HELOC that was 2.5 pts less than my mortgage rate. With this new low rate, it was definitely worth looking into. I made certain that I could pay off the HELOC early and that there were no fees. In addition, I ran the amortization numbers for several different increasing interest rates, because the HELOC rate is based on the prime rate which can change.

My intentions were to pay off my home loan within the next year, so I knew that it was very likely I would have it paid off before rates could climb back up to my original mortgage rate. That is exactly what happened. Rates did increase, but it never reached the level of my original rate before the loan was closed out.

That turned out to be a real benefit, because as the rate was increasing, I had the extra incentive to save and get the HELOC paid off within that year. The only downside of the HELOC is that I suspect it had a negative impact on my credit, at the time. Unlike a mortgage, a HELOC is a loan that can be used for anything and accordingly it presents more risk to the lender. I did some research on this and found some interesting facts.

  • HELOCs are structured as interest-only loans, so the minimum payments can be enticingly small. Case in point, I borrowed nearly $40,000 and the minimum monthly payment was less than $130 bucks.

  • HELOCs can affect your credit score. How much depends on the amount you borrow. A sizable HELOC of $100,000 is counted as an installment loan, while a small HELOC around $2,000 is considered revolving credit. For installment loans, like a large HELOC or an auto loan, FICO takes the ratio of the original loan amount to your outstanding balance on the loan to calculate a credit-utilization ratio. So a new loan can drag your score down for the first year or so. Whereas revolving credit, like credit cards, is treated a little more kindly - the ratio is the credit limit to your current monthly balance.


  1. If you only had a year to payoff, why did you bother with refinancing?

  2. That's just it - it didn't seem like it would be worth the trouble. But the lower interest rate was significant and resulted in a savings of $1000 in that one year even with a rapidly declining principal.