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Pay off mortgage with HELOC?
Old 12-20-2008, 12:32 AM   #1
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Pay off mortgage with HELOC?

We have a second home with a $92,000 mortgage at 6 1/8%. Our HELOC is now down to 3.25% (tied to prime). We are wondering whether it doesn't make sense to pay off that mortgage with the HELOC. (This would have the added benefit of allowing us to cancel unnecessary but required flood insurance.) We plan to sell our primary residence in the next year or two when we ER (and relocate), at which point the HELOC would be paid off. We would continue to make at least our normal monthly mortgage payment to the HELOC, which would reduce principal faster due to the lower interest rate.

I know that rates will eventually go up, but it seems possible that they won't hit 6 1/8% in the next year or two, at which point it will be paid off.

Thoughts? Thanks!
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Old 12-20-2008, 01:16 AM   #2
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We paid off our mortgage with a HELOC in 2003 because the interest rate was 2 points cheaper. We were in the process of paying it off and was 8 months away from being mortgage free (large monthly equity payments). We knew the HELOC was variable, but also knew that we could get the thing paid quickly. We decided to take the route you describe. We didn't save a huge amount from the interest difference, but it did feel good to game the system a little. Worked out good for us, because we paid the debt in full, as planned.

The only negative we saw, was that it was a variable loan, and the interest payment did have the potential to grow(was based off the 6 month t-bill +3%). This kept us motivated to get the debt paid ASAP.
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Old 12-20-2008, 02:53 AM   #3
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Given your time frame two years I'd say go for it. Obviously you want to keep an eye on interest rates and be prepared for a plan B if they skyrocket upwards.

The good news is if rates do exceed 6% in the next 2 years that means that inflation has returned and your house will be worth more and probably easier to sel..
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Old 12-20-2008, 05:34 AM   #4
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There are real fundamental risks in this strategy that you need to be aware of and manage accordingly.

A mortgage is a loan based on your income -- not the value of the house. House just happens to be collateral.

The benefit of a fixed mortgage is that the bank can't call the mortgage in - that was not always the case and in the Great Depression in the thirties the banks routinely could do that which resulted in a significant amount of individual bankruptcies.

A HELOC is a different instrument than a fixed mortgage. The bank has the right to cancel your HELOC at anytime and make you pay it. Check the agreement you signed. Most banks have been reducing the value of HELOCs unilaterally (happened to me earlier this year) but not calling them. That could change in this environment.

So worst case scenario, you lose your job and bank calls the HELOC in. Not saying it will happen but in times like these you need to at least think of all the downsides and compare them to the upsides to make an informed decision. Sometimes having cash in the bank plus a fixed loan is a better situation.

Cheers,
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Old 12-20-2008, 05:48 AM   #5
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There are real fundamental risks in this strategy that you need to be aware of and manage accordingly.

A mortgage is a loan based on your income -- not the value of the house. House just happens to be collateral.

The benefit of a fixed mortgage is that the bank can't call the mortgage in - that was not always the case and in the Great Depression in the thirties the banks routinely could do that which resulted in a significant amount of individual bankruptcies.

A HELOC is a different instrument than a fixed mortgage. The bank has the right to cancel your HELOC at anytime and make you pay it. Check the agreement you signed. Most banks have been reducing the value of HELOCs unilaterally (happened to me earlier this year) but not calling them. That could change in this environment.

So worst case scenario, you lose your job and bank calls the HELOC in. Not saying it will happen but in times like these you need to at least think of all the downsides and compare them to the upsides to make an informed decision. Sometimes having cash in the bank plus a fixed loan is a better situation.

Cheers,
I do not see that in my agreement on my HELOC. I have NO EARNED INCOME, and did not have any when I took out the HELOC - so no job to lose/no call. Frankly, you are right to read the agreement, but, at least, in my case as long as the interest (it is interest only) is in the transfer account (a MMA at the same institution) when they debit for the monthly payment there will be no problem. Of course in 14+ years when the Principal is due - it could be a problem (in our case I doubt it will ever be a problem).

For OP: Sure I would, and did, go for the cheap money. Just be (and I am sure you are) prudent and plan for the potential pit-falls.
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Old 12-20-2008, 08:09 AM   #6
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I did this a few years ago to pay off my mortgage -- at the time, I had a few years remaining on a 15 year mortgage. The HELOC was 3 points less than the mortgage, and I ended up paying off the HELOC within a year. I think it is a great idea if you plan to pay it off in a relatively short time frame.
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Old 12-20-2008, 08:51 AM   #7
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I paid off my mortgage with a fixed end loan secured by my house, which is different than a HELOC, but similar. Bottom line was that I paid no closing costs, got a much lower rate and it is still tax deductible.

Not sure if these type of loans are still available - this was 5 years ago.
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Old 12-20-2008, 09:05 AM   #8
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I think a consideration should be the current value of your primary, and what your LTV will be once you add enough to your HELOC to pay off the secondary. Some forecasts of home values suggest we might be a couple of years from the bottom of the home values in the RE market.
You don't want to be at the point where you will be under water when you need to sell your primary......
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Old 12-20-2008, 10:35 AM   #9
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If you have the means to pay off the HELOC in a couple years, then I see this as a clear winning plan. Fed is saying rates are expected to stay low at least a year. Even if they jump quickly (and they do sometimes rise fast when they go up) they can go even higher than your old 6% and you still win. Your balance in the future when (if) rates rise will be less (hopefuly considerably less) since you are paying off more now at the lower rate.

If you are planning to pay only the interest on the HELOC because it will be much lower than the interest on the mortgage was, then you will be taking a huge risk. But if you are paying it off soon - before rates can rise too much - then this looks like a great way to lower costs.
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Old 12-20-2008, 10:40 AM   #10
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My only concern is that plans and circumstances change. What if, for some reason, you aren't in a position to pay off the HELOC in a year or two and interest rates start increasing again?

If your plans and circumstances don't change this is a winning move. But I personally don't think there's enough financial gain to justify the risks. Variable rate debt just scares me. YMMV, naturally.
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Old 12-20-2008, 11:20 AM   #11
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I did that the last time prime was low and it was great. I was paying prime minus .75 then but prime went up fast. The only downside was it is very hard to refi a small mortgage. Mine was about 65K when I wanted a lower rate and the refinance cost made it too expensive. The cost to refi a small mortgage is almost as much as for a large one. I ended up taking a large mortgage taking out cash to invest. The cash I invested is down a little and I have been paying interest on the new amount. I am down almost 10K on the transaction. If I sold the investments now at a loss and paid towards my mortgage my monthly payment would still be high.
I would do it.
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Old 12-20-2008, 01:42 PM   #12
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OP here - thank you all so much for the quick, well thought out responses! We are in So. Cal, and even with the downturn in prices, our LTV with the HELOC and the vacation home rolled in is still only about 35% - so I am not concerned in that regard at all. As far as the bank calling the HELOC - I admit, I had not thought about that - I will have to check my paperwork. I do have friends who have had their lines cut off, but we have been lucky so far, I guess!

If it came down to it, we could refi our first with cash out - but rates for cash out refis are still fairly high, I think - so I'd rather take that as a worst case scenario down the road.

Thanks again!
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Clever Idea
Old 12-20-2008, 02:27 PM   #13
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Clever Idea

I had not thought of doing this--a year or two ago, I opened a HELOC as there were no costs/points, etc.--figured it would be good to have around in case I ever needed the money. I have a 15-year fixed rate at 5.25%--my HELOC is at 2.89%. I did the math, and it looks like if I paid off the first mortgage with the HELOC, I would save about $800 (the house will be paid off in April of 2010--about 16 months. I kind of doubt rates will stay @2.89% for that long, so given that, and the reltaively small savings, not sure it is really worth while. Still thought the OP had a clever idea.
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Old 12-20-2008, 09:52 PM   #14
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If it came down to it, we could refi our first with cash out - but rates for cash out refis are still fairly high, I think - so I'd rather take that as a worst case scenario down the road.
I'm also in So.Ca., the approach I'm thinking about, but have not yet used, is getting the HELOC, taking out the full amount and then refinancing the 1st plus HELOC. In theory this should be the equivalent of a cash out refi.
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Old 12-20-2008, 11:06 PM   #15
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As far as the bank calling the HELOC - I admit, I had not thought about that - I will have to check my paperwork. I do have friends who have had their lines cut off, but we have been lucky so far, I guess!


Thanks again!
I doubt you have been lucky more likely 92K represent a very low LTV even for declining So Cal real estate. I think it would definitely be worth a call to your bank to see under what circumstance they might be freezing your HELOC. My understanding is that most banks who have been freezing HELCO have been doing so when there was a real danger that the 1st+ HELCO exceeded the value of the home.
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Old 12-21-2008, 06:58 AM   #16
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I doubt you have been lucky more likely 92K represent a very low LTV even for declining So Cal real estate. I think it would definitely be worth a call to your bank to see under what circumstance they might be freezing your HELOC. My understanding is that most banks who have been freezing HELCO have been doing so when there was a real danger that the 1st+ HELCO exceeded the value of the home.
I would suggest that, if you cannot afford the answer, do not ask the question. If I was really worried about getting cut off, and thought I wanted to have the money, just withdraw the money to the limit and find someplace to put it that would match the interest rate and was "safe".
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Old 12-21-2008, 09:57 AM   #17
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The other thing I would do is to make sure I had earthquake coverage on my HO insurance. There is nowhere in SOcal that is safe, and any nearby magnitude 6 or higher would take a frame house off its foundation......even with a 10% deduct, you could be ahead.
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