Ask Money

Swap mortgage for home equity loan?

Chris Farrell Oct 14, 2011

Question: My mortgage rate is 6.5% and I was laid off over a year ago. I owe only $39,000 and have a home equity line of credit of $100,000 which I owe nothing on. The interest rate on the Home Equity line is 1 1/2@ above prime. Would it be a good idea to pay off my mortgage with my Home Equity line? How much could I save a month doing this? Thank you, Sherrard, Roslindale, MA

Answer: The answer largely depends on how fast you can pay down the mortgage. The cost savings won’t be much, but every little bit helps. The interest rate on the line of credit would be an initial 4.75% (The prime rate is currently 3.25%).

I don’t have all the critical details, such as how long you have left to go on your mortgage. However, to give you some perspective I went to a mortgage calculator and ran some numbers.

I assumed you had 5 years left on the mortgage and no fees. On a monthly basis you would save $31.56 or $378.72 a year. Over the course of 5 years the savings would amount to $1,893.66 ($45,784.84 minus $43.891.18).

The numbers will vary depending on the length of the mortgage. You should play around with the calculation.

The drawback to the strategy is the risk that the rates will increase on your home equity line of credit. It’s hard to believe right now with the economy sputtering and interest rates at record lows. Still, you have to consider the odds that rates will rise over the next couple of years. Higher interest rates would decrease the savings from the maneuver or even end up costing you more.

Your time horizon is a critical factor in the calculation. If you could pay off the loan in, say, in a year, the nearly $400 in savings is a nice chunk of change and ther risk of higher rates minimal. I would become increasingly wary the longer it takes you to pay off the debt. I don’t think the upfront savings are enough considering the downside risk.

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