Paying mortgage with HELOC is risky

Dear Dr. Don,
I am 75 and basically retired, although I do a bit of college teaching as a part-timer. I have a mortgage balance of $46,383 on a 15-year note at a fixed rate of 5.25 percent and a monthly mortgage payment of $603. I also have a home equity line of credit at a current rate of 4.49 percent. Would it make sense to use the HELOC to pay off the mortgage?
— Karl Credit

Dear Karl,
I backed into the months remaining on your mortgage given the mortgage rate and the loan balance. You should have about 94 months remaining on your existing first mortgage, or about 7.83 years.

I assume you’ve got enough room on your HELOC to pay off the first mortgage. The HELOC is an adjustable-rate loan, but may have a floor interest rate that it can’t fall below. The interest rate on a HELOC is typically the prime rate plus a pricing spread. The prime rate is currently 3.25 percent.

You can track the prime rate using Bankrate’s Rate Watch feature.

You should review your HELOC documents to confirm the index, pricing spread and any floors — or ceilings, for that matter — on the interest rate. Also, find out if and when the HELOC becomes an amortized loan, meaning the monthly payment covers both principal and interest over a remaining term.

In the table below, I assume you would pay the HELOC balance off over the same time frame as your mortgage. You can construct your own table using Bankrate’s mortgage calculator. The table also assumes the HELOC rate stays constant over the term of the loan. That isn’t likely, however.

Mortgage vs. HELOC
Existing mortgage HELOC
Loan amount: $46,383.00 $46,383.00
Interest rate: 5.25 percent 4.49 percent
Loan term (months): 94 94
Mortgage payment: $602.90 $586.20
Additional principal payment: $ – $ –
Total monthly payment: $602.90 $586.20
Total payments: $56,672.00 $55,371.00
Total interest: $10,289.00 $8,988.00
Difference in total interest: $1,301.00
Estimated loss of mortgage interest deduction

(15 percent):



In the near term, it’s likely the HELOC rate will stay below the interest rate on your existing mortgage. However, in the back half of the loan repayment plan, it’s likely the rate on the HELOC will exceed 5.25 percent.

Of course, by then you’ve got a smaller outstanding loan balance. But that would be true with your existing mortgage, too.

The estimated loss on the mortgage interest deduction assumes a 15 percent marginal federal income tax rate, and that you can fully use the mortgage interest deduction on your taxes. That means the mortgage interest deduction isn’t just replacing the standard deduction on your taxes. The estimate doesn’t consider how that loss of a deduction is spread over the mortgage term, so it’s slightly overstated.

Refinancing into a new first mortgage isn’t likely to make sense because of the high closing costs, even though you should be able to lock in a fixed rate on a 15-year mortgage below the current interest rate on your HELOC.

Do you use your HELOC as a substitute for an emergency fund? If so, I don’t like the idea of using up loan capacity to pay off your existing mortgage. If that isn’t an issue, you have to weigh whether it’s worth it to you to take on the potential interest rate risk of rising HELOC rates to possibly capture some interest savings. Personally, I wouldn’t do it.

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