home loan or mortgage is the financial baggage most people wish to get rid of sooner. The mortgage loan is generally for 30 years where you have to pay monthly payments and principal amounts to own the home you have been living in finally.
It's a dream for many people to fully pay off the mortgage to own the place they have been calling home. It's the most incredible sense of achievement for many.
But, it would take years to live that dream. Wouldn't it be great to pay off your home loan early and live a debt-free life?
It seems impossible, right? But, with just financial tricks and strategy, you can pay off your home loan early and live that dream.
On the verge of paying off the mortgage loan, you probably have forgotten about the equity you own and how you can use that equity to pay off your loan.
This article talks about how you can pay off your home loan faster with your home equity through a home equity loan of credit (HELOC).
What Is Home Equity?
Home equity is the amount of the home that you own. It is the fair market value of your home minus the mortgage loan you owe.
When you purchase a home with a mortgage loan, you have to invest a specific portion with your own money. You can borrow the rest from the bank. The amount you have invested in your home is your equity, and the rest is the liability.
The liability decreases with the loan repayments, and once you have completely paid off your mortgage loan, that's when you fully own the property.
For instance, If your home is worth $500,000 and you owe $400,000 on a mortgage. You own $ 100,000 ($500,000 - $400,000) in equity. The $100,000 is your portion of investment in the home in which you have full ownership.
Suppose you sell your home for $500,000, then you have to pay $400,000 to your lender, and the remaining $100,000 is yours.
Thus, you can use this equity to borrow a second mortgage, such as a home equity loan or home equity line of credit (HELOC).
What Is HELOC?
A home equity line of credit (HELOC) is a secured loan against a home's equity. It's like a second mortgage where you can cash out the money based on the home's value that you own.
The amount borrowed from HELOC can be used in anything from the home's renovation, hospital bills, education bills, or to pay off the mortgage loan.
How Does HELOC Work?
The HELOC, similar to any other line of credit, is deposited into an account, and you may withdraw as much or as little as you want.
However, there are no fixed repayment amounts. Instead, the lenders expect you to pay monthly interest on your borrowed amount.
The available credit is restored when you repay your outstanding debt like a credit card. You can borrow as you need for your draw period, which is usually ten years.
When the draw period of a HELOC expires, you begin the payback period. Then, the loan is converted to a repayment plan with monthly principal and interest payments.
Your monthly payments are primarily determined by how much you borrowed because you are only charged for your outstanding debt after your draw period.
Repayment lengths vary depending on the conditions of your agreement, but they commonly range from 10 to 20 years. You will not be able to make any more drawings during this period.
Criteria For HELOC
There are some criteria that you must meet to get a HELOC. The requirements may differ based on the lender, but here's what you'll typically need to receive a HELOC:
- A debt-to-income ratio of no more than 40%.
- A credit score of 620 or above is required.
- A property worth at least 15% more than what you owe.
How Does HELOC Help To Pay Off The Home Loan Faster?
A HELOC differs from a regular mortgage in several ways. The primary point that typical HELOC differs from a traditional mortgage is that HELOC is a revolving line of credit. It uses an average daily interest calculation ( simple interest) rather than an amortization interest calculation.
Thus, the basic strategy is to use HELOC to replace your 30 years amortized mortgage. The simple idea is to borrow the HELOC loan to pay your mortgage loan.
As a result, you only have one debt against your property, and you do not have to pay amortized interest anymore.
However, you still have to pay a HELOC loan. Since the HELOC is calculated based on the average daily interest rate, the interest amount is less than the amortized 30-year mortgage loan.
On top of that, you can deposit all of your income to the HELOC to reduce the average daily balance, which reduces the daily interest amount you'll pay.
This will keep the interest cost low while allowing you to withdraw the cash for expenses, emergencies, and other investments.
For instance, you have a property worth $300,000 with a mortgage balance of $200,000. Generally, the maximum limit of HELOC is 80% of your equity, which in this case is $80,000.
Since you have approved the $80,000 HELOC limit, the amount is deposited in your account. So now, since you have $80,000 in your account, you can pay off a $200,000 mortgage from it.
After that, your mortgage balance is reduced to $120,000. Technically saying, your debt isn't reduced, it's the same, but the interest you are paying is entirely different. This helps in saving your interest amount.
You can deposit your savings and income in HELOC to reduce the HELOC balance to save the interest amount. For example, suppose your income is $6,000, and depositing your payment in HELOC balance would reduce your balance to $74,000.
The interest on $74,000 is less than the interest on $80,000.So, what you have to do is reduce the balance of the HELOC so that you would pay low interest.
You might be wondering about the expenses since we are not using monthly income. Well, there is a credit card that comes in handy. You can use a credit card to pay for expenses such as gas and groceries.
You can use the credit card and pay off the credit card debt with a HELOC balance before you are charged interest.
This helps you save the interest from HELOC and pay for the expenses from your income. In addition, this will keep the interest income, which ultimately enables you to pay off the HELOC quickly.
Thus, the main idea behind using HELOC is using the saved interest amount to pay off your loan faster.
Pros Of HELOC
- Lower interest rate
HELOC interest rates are calculated as simple interest, whereas home loans are calculated as amortized interest. The interest on the HELOC is low compared to the home mortgage loan since they are issued on the secured assets.
You'll accrue less interest than the original interest amount when you pay off your mortgage with HELOC. Of course, you have to pay off HELOC, but the interest rate is low compared to the mortgage loan.
- No restrictions on the use of fund
There are no restrictions on the use of funds. The loans borrowed with HELOC can be used for home renovations, education, hospital bills, or investing in other assets. You can withdraw the amount up to the limit, and there are no restrictions on how you use that fund.
HELOCs allow you to borrow cash overtime as needed. They also provide flexible repayment choices, like interest-only payments to qualified individuals. There are also fixed-rate HELOC alternatives available, which allow you to lock in a rate on the amount borrowed.
Cons Of HELOC
- Interest rates may rise
Since home equity line of credit (HELOC) has variable rates, your rate may rise or fall over time. As a result, your monthly mortgage payments may be unpredictable, and you may end up paying more interest on the HELOC than you would on your initial mortgage.
- Risk of default
A HELOC, like a home equity loan, is backed by your home. If you cannot repay the loan, your lender has the authority to initiate foreclosure procedures, and you may lose your home.
Easy access to cash may be helpful for home improvements and emergency purchases, but if you are not disciplined, you may be prone to spending above your means. Thus, it is essential to make sure that you only borrow when necessary.
- Credit freezes
Even if the loan hasn't expired, the bank may block your credit line in certain circumstances, such as if the value of your property falls below the amount appraised when you took out the HELOC. This implies that you won't be able to use the HELOC funds you depend on.
There are several lending institutions that can help you with questions and process to get started with and obtain a HELOC loan. Here are a few to get started off with.
"A great rate is just the beginning". AmeriSave believes that everyone deserves a place to call their own. That’s why we give people a more straightforward, simpler way to buy and manage their home financing. For over 20 years, AmeriSave has helped more than 664,000 borrowers realize the dream of homeownership through the refinance and purchase processes.
Buying a home is one of the biggest financial decisions many of us will make. Flagstar Bank helps make that process easier. Explore the following mortgage resources for more home loan information, such as home-buying tips and answers to frequently asked questions.
"less is so much more". Loan Pronto has developed a digital mortgage process that streamlines your experience, thus saving you time, money, and a lot of paper.
"Find Your Perfect Home Loan Today" . Founded in 1909, Mutual of Omaha serves over 4.6 million individual product customers and 36,000 employer groups.
Founded in Cleveland in 1938 as a mutual association by Ben and Gerome Stefanski, Third Federal’s mission is to help people achieve the dream of home ownership and financial security
Home line equity of credit (HELOC) is a practical financial technique to pay off mortgage loans faster. The central idea behind this technique is to save the interest amount to pay off the loan.
However, there are some criteria and things to consider before applying for the HELOC. If you meet the requirements and considerations, then HELOC can be a debt-destructive weapon for you.