A $300,000 Mortgage Paid Down Three Ways: What the Line of Credit Routine Really Changes

Ask whether the routine works and you will get two loud answers. One side shows a mortgage melting away in seven years. The other side calls the whole thing a trick. Fewer people sit down with one mortgage, one household budget and a calculator, and check.

That is what this page does. It takes a $300,000 Canadian mortgage and a household with $1,000 left over each month. Then it pays the mortgage down three ways: with regular payments only, with the surplus sent straight to the mortgage, and with the routine people call "velocity banking", where pay and spending run through a home equity line of credit. Every figure is computed from the same assumptions, so the comparison is fair.

Why bother with the arithmetic? Because a mortgage is likely the largest debt you will ever carry, and a routine that runs your whole budget through a line secured by your home is not a small change. You deserve to know what it does before you rearrange your finances around it. This page is general information from a licensed insurance professional. It is not mortgage, tax, legal or investment advice, and it does not recommend a lender, a mortgage or a line of credit.

Start with the assumptions, because everything else depends on them.

What does the worked example assume?

Illustrative example. The household has a $300,000 mortgage with a 25 year amortization and a fixed rate of 4.50%, compounded half-yearly. Section 6 of the Interest Act requires a blended-payment mortgage to state its rate calculated yearly or half-yearly, not in advance, and this example uses half-yearly. At that rate, the monthly payment is $1,660.42.

Take-home pay is $8,000 a month, paid in two equal amounts on the 1st and the 15th. Living costs other than the mortgage come to $5,339.58 a month, spent evenly through the month. That leaves a surplus of exactly $1,000 a month after every expense, including the mortgage payment.

For the routine, the household opens a line of credit at 6.45%, charged daily on the balance drawn and added monthly. It moves money from the line to the mortgage in chunks of $10,000, the first one on day one and each later one when the line is back to zero. In the comparison, nothing changes for twelve years: no rate moves, no term renews at a new rate, no job is lost, no spending creeps up.

These numbers are assumptions chosen to show the arithmetic. They are not a rate any lender has quoted, and your own figures will differ. The simplifications matter too, and they are listed further down. What the assumptions do give you is a fair test: the same mortgage, the same pay, the same spending, and the same $1,000, used three different ways.

What happens with regular payments only?

Nothing surprising. The household pays $1,660.42 a month for 300 months. The mortgage ends after 25 years. Total interest comes to about $198,126, so the household pays about $498,126 in all to borrow $300,000.

The early years feel slow because the balance is largest at the start. In the first payment, about $1,115 is interest and only about $546 goes to principal. That pattern is not a special kind of interest or a trick in the contract. It is the same rate charged on a large balance. As the balance falls, more of each payment reaches the principal.

The $1,000 surplus is not used in this version. It goes to savings, to spending, or to something else. Keep that in mind, because the other two versions do nothing more mysterious than put that $1,000 to work against the debt.

What happens if the surplus goes straight to the mortgage?

The household raises its monthly payment from $1,660.42 to $2,660.42. Nothing else changes. No line of credit, no chunks, no new account.

The mortgage is gone in 147 months, which is 12 years and 3 months. Total interest drops to about $89,495. Against regular payments, that saves about $108,631 and nearly thirteen years. All of it comes from one habit: sending the money that is left over to the debt, every month, without borrowing it back.

There is a second plain version of the same idea. Instead of raising the payment, the household saves the $1,000 each month and pays a $10,000 lump sum against the mortgage whenever the savings reach that amount. The result is close: about 150 months and about $92,774 of interest. It costs a little more because the money sits in savings for a few months before it reduces the balance.

Check your contract before you try either one. The Financial Consumer Agency of Canada says your lender calls this a prepayment privilege, that you may only be able to increase your payments by a certain amount each year, and that going over the maximum triggers a prepayment penalty. Raising the payment by 60%, as this example does, is allowed by some contracts and not by others. A federally regulated lender must show these privileges and charges in one information box in your mortgage agreement, so the answer is written down. Read it.

What happens with the line of credit routine?

Here the household follows the routine step by step. It draws $10,000 from the line on day one and pays it against the mortgage. Both paycheques go into the line, which lowers the balance. All spending, including the regular mortgage payment, is drawn from the line. Because pay comes in faster than spending goes out, the line drifts back toward zero. When it reaches zero, the next $10,000 chunk goes to the mortgage, and the cycle starts again.

The mortgage itself is paid off in 143 months, which is 11 years and 11 months. That is the number that looks most impressive. It is not the whole story. When the last chunk clears the mortgage, the line still owes part of it. The household needs four more months of surplus to bring the line back to zero. Every debt is gone after 147 months, or 12 years and 3 months.

Total interest is about $86,736 on the mortgage plus about $2,762 on the line, or about $89,498. Set that beside the plain extra payment: 147 months and about $89,495. The routine finishes in the same month and costs about $3 more.

In other words, a household could follow every step of the routine for twelve years and end up exactly where it would have been by raising its mortgage payment once.

Why are the two results almost the same?

Because the same $1,000 is doing the same job in both cases. Each chunk is borrowed money. It moves debt from the mortgage to the line, and the line is then repaid from the same monthly surplus that could have gone straight to the mortgage. The household's total debt falls only as fast as the surplus allows.

The routine does have two small effects, and they pull in opposite directions. First, parking each paycheque against the line lowers its balance for a few days, so the line charges a little less interest. Second, the chunk sits on the line at 6.45% while it waits to be repaid, and that rate is higher than the mortgage rate of 4.50%. In this example the two effects nearly cancel.

Change the line's rate and you can see which effect wins. The table keeps every other assumption the same.

When the line costs the same as the mortgage, the routine saves about $1,109 over twelve years, roughly $90 a year, and finishes one month sooner. That is the real value of parking pay against a debt. When the line costs more, the saving shrinks and then turns into a cost. Compare the rate on your own line with your own mortgage rate to see which row you are in.

Neither result is large. Neither one comes close to turning a 25 year mortgage into a 7 year one. The large saving in this example, about $108,000 against regular payments, belongs to the surplus, and the surplus is available with or without the line.

What happens when the surplus is smaller, or zero?

Run the same example with a $500 surplus instead of $1,000. Raising the mortgage payment by $500 clears the debt in 196 months, about 16 years and 4 months, with about $122,654 of interest. The routine with a $500 surplus also takes 196 months, with about $123,066 of interest. The pattern holds: the same time, and a slightly higher cost for the routine, because the line's rate is higher.

Now take the surplus away. The household spends what it earns, and the line never comes back to zero. The first $10,000 chunk still reduces the mortgage, but the household now owes $10,000 on a line at 6.45% instead of on a mortgage at 4.50%. If the line's interest is simply added to the balance, the $10,000 grows to about $13,794 after five years. The mortgage is shorter. The household is not better off.

This is the version that worries critics, and for good reason. The Financial Consumer Agency of Canada puts it plainly on its lines of credit page: paying only the interest means you will never pay off the debt. A routine that depends on a surplus does nothing for a household that does not have one, and it can leave that household with a growing balance on a line secured by its home.

Ask yourself this. Over the last twelve months, how much was really left over each month, on average, after everything? Not the amount you hoped for. The amount that was there.

What does the example leave out?

A worked example is only as honest as its list of simplifications. Here is this one's.

The rates never change. In real life, a line of credit is usually variable. The Agency says the rate will change as market interest rates go up or down. A mortgage term also ends after a few years and renews at whatever rate applies then. Both changes affect both versions, but the routine carries more of its debt at a variable rate.

The line never shrinks. The Agency's home equity page says you may borrow up to 65% of your home's value with a home equity line of credit, and that your home acts as security. A line is credit the lender has agreed to extend on terms in your agreement, and those terms decide what the lender can change. The plain extra payment does not depend on a line at all.

Nobody slips. The example assumes the household never treats the open room on the line as spending money. That assumption is the hardest one to keep in real life, and it is the one the plain extra payment does not need.

There are no fees, no penalties and no taxes in the example. Some lines and mortgage products carry fees. A prepayment above your privileges carries a penalty. Whether any interest is deductible depends on how the borrowed money is used, and the Canadian rule, which differs from the American one, is explained on the companion page about the routine and a policy loan.

The timing is simplified. Pay arrives on two fixed days, spending is spread evenly, and interest on the line is worked out daily and added monthly. A household whose spending lands early in the month would save a little less from parking pay. One whose income arrives weekly would save a little more. None of these details changes the main finding.

What is the fastest way to pay off a $300,000 mortgage?

The fastest safe way is the one this page keeps returning to: pay more principal, sooner, with money you do not need to borrow back. The Agency lists three ways to do that: increase your regular payments, make lump-sum payments, and switch to accelerated weekly or biweekly payments.

The accelerated option is the easiest to start, because it needs no surplus decision each month. The Agency explains that accelerating your payments means you make the equivalent of one extra monthly payment per year. In this example, paying $830.21 every two weeks instead of $1,660.42 every month clears the mortgage in about 21 years and 8 months, with about $168,079 of interest. That alone saves about $30,000 and more than three years.

Add a steady surplus on top of that and the mortgage shrinks much faster, as the second version showed. The order of operations is simple. Know your prepayment privileges. Decide how much surplus you can rely on. Send it to the mortgage within those limits. Keep a reserve for emergencies so that one bad month does not send you back to borrowing.

Where does a policy loan fit in this example?

Some presenters suggest replacing the line of credit with a policy loan. The idea is the same routine with a different lender: borrow from an insurer against the cash value of a specially designed, high-cash-value, participating whole life insurance policy, pay the chunk to the mortgage, and repay the policy loan from the surplus.

The arithmetic in this example still applies, with three differences you should weigh. The lender becomes the insurer, at a rate set under the contract, and interest on the loan is paid to the insurer. The policy must first build enough cash value to lend against, and that takes years of premiums. And those premiums come out of the same monthly surplus that would otherwise go to the mortgage. A household cannot spend the same $1,000 twice.

That does not make a policy wrong for every household. It means a policy is life insurance with a long commitment, and it should be chosen for that reason, not as a faster mortgage routine. How a policy loan works is on policy loans. Why its rate and the dividend are not two numbers you can subtract is on policy loan interest against dividends. The full side by side comparison of the line and the policy loan, with the Canadian lending and tax rules, is on the line of credit routine and a policy loan.

How can you run this check on your own figures?

You do not need special software. You need four numbers and an ordinary mortgage calculator that lets you add extra payments. The Agency publishes one.

First, write down your mortgage balance, rate and remaining amortization from your latest statement. Second, write down your real monthly surplus, averaged over the last twelve months. Third, ask your lender in writing for the current rate on a line of credit and how it can change. Fourth, read your prepayment privileges in the information box of your mortgage agreement.

Then run two versions. In one, add your surplus to the mortgage payment, within your privileges. In the other, add the same amount and assume the extra borrowing costs the line's rate for a few months at a time. If the first version is already fast, the routine will not make it much faster. If the first version barely moves, the problem is the surplus, and no routine can fix that.

Bring your own figures to this. A presenter's spreadsheet uses a presenter's assumptions. Yours should use your pay, your spending and your contract. The site's page on paying off the mortgage or saving first works through what to do with a surplus once you know how large it really is.

Who does the routine not suit?

It does not suit a household without a steady monthly surplus. The example shows why: without one, the line never returns to zero, and the household ends up paying a higher rate on part of its mortgage.

It does not suit uneven income or uneven spending. The routine relies on the line drifting back down every month. A commission income, a seasonal business or a year of large repairs can stall it for months, while the line's interest keeps running.

It does not suit a household that finds open credit hard to leave alone. Running all spending through a line of credit means living every day beside unused borrowing room. Some people manage that well. Others do not, and the routine gives them no protection.

And it does not suit a household that could not cope if the line's rate rose or its limit changed in a difficult year, because the home secures the debt.

For a household with steady income and real discipline, the routine can work. It simply does not work better than sending the same money straight to the mortgage. The wider set of objections to borrowing strategies, stated fairly, is on the objections and risks page. What any fair comparison has to hold constant is on the comparison question.

What this page will not tell you

It will not tell you whether to open a line of credit, change your mortgage, switch your payment schedule or buy a policy. Those choices depend on your income, your spending, your home, your health and your other goals. It will not quote a lender's rate or an insurer's loan rate, because each belongs to one company on one date, and each changes.

What it can leave you with is one clear test. When anyone shows you a mortgage disappearing in a few years, ask what surplus they assumed, and then ask what that same surplus would do if it went straight to the mortgage. In this example, the answer was the same month, give or take a few dollars. The surplus is the engine. Everything else is plumbing.