Dear Dr. Don,
I've heard of a mortgage strategy that involves getting an equity line on the house and using that money to pay bills you know you would have to pay anyway, along with the mortgage payment. The end result is that you can pay off all your debt faster. Fact or fiction?
-- Chris Conundrum
Fiction. I don't like writing about this topic, because when I come out against it, every sales representative pushing this product writes in to tell me how I just don't get it. I get it just fine. I just don't think the typical homeowner benefits from this type of mortgage loan.
Some of these programs even sell you software packages to manage the process. I have a loan program you can use for free. Enter your mortgage particulars on Bankrate's mortgage calculator, then add an additional monthly principal payment each month and see how it changes your payoff date and total interest expense.
Yes, if you put every penny you can into paying down your mortgage, you will pay the loan off faster and own your home free and clear sooner. You don't need a home equity line to do this, just make additional principal payments on your conventional mortgage loan.
The premise of the equity line program is that you deposit your paycheck into your home equity line and then write checks against the credit line to pay your bills. As long as your income is greater than your expenses, you're paying down the credit line and reducing your mortgage interest expense.
The fallacy is that by depositing your entire paycheck into the home equity line, you substantially reduce the intramonth interest expense. You do reduce that expense, but the amount isn't substantial. Let's say that your loan balance is $200,000 at a 5 percent annual interest rate. Depositing a $4,000 paycheck at the beginning of the month and then drawing down $4,000 on the line during the month, if you do it equally over the month, it reduces your average mortgage balance during the month by about $2,000. One month's interest on $2,000 at 5 percent is $8.33.
The real interest savings comes from making additional principal payments on your loan. You don't need a home equity line of credit to make additional principal payments on your loan. Just do it.