There’s a new mortgage technique that’s gaining popularity in the United States. This is the first I’ve heard of it, and I don’t like it, even though the technique supposedly allows people to pay off mortgages faster, saving interest expense (but losing investment opportunity and the reverse effect of inflation).
The premise users a home equity line of credit (HELOC) instead of a mortgage. Every time you get paid, your paycheck is deposited directly into the HELOC as if it were a checking account. From this account, you can pay your bills other regular expenses, again as if the HELOC were a checking account. Anything left over is automatically applied to building your equity in the house.
The plan works if you are sure that your expenses will never outpace your income. If they do, you draw on the line of credit, which has a variable interest rate unlike a fixed rate mortgage.
Paying off debt tied to your home is a great idea, but I don’t like the way this product is structured. It does force the borrower to pay the loan off faster, but only if they are earning more than they spend. Here’s another drawback, from the article on CNN:
“It’s an interesting concept,” he said, “but looking at the amortization is very complicated. It’s almost impossible to know if it works out for you. You can’t see how the actual borrower’s behavior affects it.”
I’d prefer not using this type of arrangement. It locks you in to using a home equity line of credit when you may not necessarily need one otherwise. Simply obtaining a mortgage that allows you to make extra payments would be the better option, simply because it affords the most flexibility.
Updated January 16, 2010 and originally published August 2, 2007.