Mortgage Reduction Strategies (2)

Method 2 – Use a Home Equity Loan/Line of Credit: taken from http://www.financiallyfree.com.au/mortgage_reduction.htm

A Home Equity Loan, or Revolving Line of Credit as they are commonly referred to, applies the same principle as the 100% Offset account in that it enables every dollar of your income and savings to be used to reduce the mortgage interest.

However, it’s probably fair to say that a Home Equity Loan is only suitable for people who maintain a budget and STICK to it. There are three important considerations with using a Home Equity Loan for mortgage reduction purposes versus using a 100% Offset account:

1. Home Equity Loans are interest only loans and have no term, hence you are not constrained to ever pay it off

2. Your credit limit is normally 80% of the value of your home, which could be hazardous for those who are tempted to stick their hand into the cookie jar for discretionary spending purposes!

3. The interest rate on a Home Equity Loan is generally a little higher than for a standard variable rate loan, maybe 0.5% as an example

For those who are disciplined, a number of advantages apply to Home Equity Loans:

1. You can consolidate other loans and credit cards which are on a higher rate of interest into the lower rate Home Equity loan

2. They’re generally portable, hence saving you on application fees and establishment costs should you move house in the future

3. More aggressive or sophisticated home owners could use their equity to invest at a higher rate of return & use the returns to pay off the principal on the debt faster

See the section entitled Home Equity Loan/Line Of Credit in the article The Different Types of Home Loans for more detail on this type of loan.

Putting aside the features and flexibility of these loans as detailed in that article, the example we used for Heath and Melissa in Method 1 would yield essentially the same result if they had used a Home Equity Loan. They would still slash 14 years off their home loan and save nearly $100K in interest.

A final word: if you spend more than you earn, then this is definitely not the option for you. Stick to a 100% Offset account.

It’s best to do a budget first and set a goal as to how much you want to have paid off the loan at the end of each year. Put dates on your plan and work out what the loan balance will have to be at the end of each month in order for you to get there. And finally, and most importantly, after setting up your Home Equity Loan, review your expenditure against your budget plan monthly.

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