Using the HELOC strategy to buy rentals

Denver, CO · Member since 2017 · 142 posts · 104 votes

I am in the process of obtaining a HELOC on my primary, with plans to buy some rentals. I've been doing a lot of research on how to pay down the HELOC faster using it as a checking, and have some questions as things are getting a bit muddied.

I'm debating on buying 2-3 properties cash (HELOC money). I think this would allow me to make a more aggressive offer, and saves me about 3% in closing costs per property. I was planning on using all the cash flow from the rentals to pay down the HELOC faster. In addition, I plan to deposit extra income left over from my paycheck. At this rate, my plan is they should be paid in 6 years. At that point, I would start over. With 6 properties, the cash flow shouldbe more and those 3 properties paid in 3 years or so.

Pros: More aggressive cash offers, save on closing costs, pay down HELOC faster.

Cons: HELOC interest is no longer tax deductible, while a typical mortgage on the rentals would be. Will take me 3 years to buy more rentals paying cash.

My other dilemma is if I buy the rentals in an LLC, and use the cash flow to pay off the personal HELOC, what issues am I getting into? Should I even put them in an LLC?

I also wanted to invest in some private notes and use those profits to pay down the HELOC faster.

What all do I need to do?

TIA

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Arlen Chou

Investor · Los Altos, CA · Member since 2014 · 942 posts · 1k+ votes

@Alex Corral as some have pointed out, there are still tax advantages to a HELOC, you just need to document things more clearly so that the trail of money is more obvious. The key to this strategy is to find a competitive HELOC. My current HELOC is for over $1M on a 10 year draw at prime MINUS 1%. I pay down my loan at an accelerated pace by calculating what my monthly nut would be if I had a higher fixed rate mortgage and paying that amount vs what is actually due. The delta is applied to principle. If I need money in a pinch I can access it easily with the HELOC. With a traditional loan I would be behind the eight ball and potentially need to do a "cash out refi".

But rates are creeping up very quickly, so I am currently refinancing my HELOC into a 5 year fixed rate HELOC at 3.5%. Using the HELOC strategy makes you look so much stronger in a tough market. Once the property was seasoned, I pulled a stand alone commercial loan and recharged the HELOC. Once my refi is in place I will be ready to go shopping again.

The HELOC strategy is really like a "self funded" short term bridge loan, that allows you to get into the property.

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Joe SplitrockPro Member
Moderator
Rental Property Investor · Sioux Falls, SD · Member since 2015 · 9k+ posts · 18k+ votes
8y
Originally posted by @Gerard Charles:

What about if you use heloc as a down payment you buy a duplex , live in one and rent the other. It will be my primary resident but will be renting the side. Will it still consider tax deductible ?
The use of the funds determines whether you can use it as a tax deduction, so you could deduct part of it. Only for the portion of the duplex that is used for rental. So if both sides are equal, only half the interest could be claimed. The other half would be personal mortgage interest, if you are itemizing.
1 Reply
Alex Corral
OP
Denver, CO · Member since 2017 · 142 posts · 104 votes
8y
Originally posted by @Joe Splitrock:

Originally posted by @Alex Corral:
@Joe Splitrock that is my plan A2 :) I still prefer my original plan, because if I'm doing it right, I can save on the closing costs required for a mortgage.
Here's my spread sheet. I have an extra $1700 a month left over in income. And if I buy 3 rentals that will net $2000 a month, I would pay $3700 into the $200k HELOC balance at a 5.5% rate. I won't have money going to savings, but that's ok because I should be saving a lot in interest, and still have access to cash via the HELOC.
I'm still learning, so let me know if I made a mistake.
I need to run a spreadsheet paying the extra $1700 + net rent from that property, to compare exactly. So, If I bought 3 rentals with 3 mortgages, I would have to pay their net rent after debt service, + $567. Again, the con is I'm basically broke trying to pay down those mortgages only to have the money sitting as equity.
I don't think there is a problem with your spreadsheet. I just went to a fixed rate mortgage calculator and punched in $200,000 at 5.5% and term of 63 months. The payment would be $3662.18 for 63 months and total repaid is $230,717.50. If you change the rate to 4.5%, it saves around $5000 worth of interest.
Obviously there is no option for 63 month fixed rate mortgage, but even if you take out a 30 year mortgage, then pay $3662.18 per month, the loan will be paid off in 63 months with $230,717 paid back. On a 30 year fixed, the payment would be $1135.58, so you would be required to pay that minimum, which is well under your $2000 rent. When you pay the extra principal, you just accelerate the 30 year and turn it into a 63 month loan.
I hear what you are saying on closing costs, but I still think there is higher risk of rate fluctuation. Each percentage point of interest is going to cost you roughly $5000, so you have to decide what the risk is.
As far as your last comment about being broke paying down the mortgages with money stuck as equity, that is not really the case. Since you still have the HELOC, you have access to even more money. You could even float the payment each month from your HELOC, so if your spending is higher one month, you just have a little balance on the HELOC until the next month.
Right right. I was thinking in case I did not take out the HELOC. Thanks for your help. I think getting a HELOC will be beneficial anyway, as some can be found as low as 1.99% for 6 mos. Can pay as much into it as possible to reduce the balance, then refi if rates start to climb. If rates do climb, can still use HELOC for cash offers and refi asap after. But, the access to that cash is invaluable.
1 Reply
Lana Lee
Philadelphia, PA · Member since 2017 · 364 posts · 109 votes
8y
Originally posted by @Joe Splitrock:

@Alex Corral there is lots of mis-informaiton about HELOC interest in the forums. I have participated in discussions around this and the split is between people who understand how interest works and people who don't.
Interest accrued on a HELOC and fixed rate mortgage is calculated the same and is based on the outstanding balance and interest rate. In other words, if I took out a HELOC for $100,000 at 4% and paid monthly even payments over 30 years, it would be the same as a 30 year fixed rate mortgage at 4%.
The only way to pay off the loan faster is by paying more principal. If you applied the same principal payments to a 30 year fixed rate mortgage as you did your HELOC, it would pay off just as fast. In the comparisons I have done, usually the HELOC takes longer and you pay more interest, because of the higher interest rate on the HELOC.
The advantage of the HELOC as a "savings account" is that all your capital goes immediately towards principal pay down. People find it easier than making extra principal payments on a mortgage. The other consideration is that once you make a principal payment to a mortgage, the cash is gone towards equity. With a HELOC you can just take the money back out if you need it.
I like your strategy of using the HELOC to make cash offers. In today's competitive environment, that gives you and advantage. I would refinance the properties into 30 year fixed rate mortgages to lock in low interest rates. Your HELOC is variable and the way the FED is raising rates, you will be stuck paying 1-2% more interest in a year or two. You are better off locking in the low fixed mortgage rates and making extra principal payments.
You can still find a HELOC product with fixed rate, if you don't mind paying principal and interest every month. We are very new to investing and are not comfortable with anything floating :-). So we decided to set a fixed HELOC with 3.99 rate, 3 years draw period and 10 years Amortization. Kinda short draw period, but $0 closings costs is great and we can apply again in 3 years , if that strategy works out for us.
4 Reply
Alex Corral
OP
Denver, CO · Member since 2017 · 142 posts · 104 votes
8y
@Lana Lee
I would love to have that deal. I checked with the CU you told me, but they don't lend in that my State.
0 Reply
Arlen Chou
Investor · Los Altos, CA · Member since 2014 · 942 posts · 1k+ votes
8y
@Alex Corral as some have pointed out, there are still tax advantages to a HELOC, you just need to document things more clearly so that the trail of money is more obvious. The key to this strategy is to find a competitive HELOC. My current HELOC is for over $1M on a 10 year draw at prime MINUS 1%. I pay down my loan at an accelerated pace by calculating what my monthly nut would be if I had a higher fixed rate mortgage and paying that amount vs what is actually due. The delta is applied to principle. If I need money in a pinch I can access it easily with the HELOC. With a traditional loan I would be behind the eight ball and potentially need to do a "cash out refi".
But rates are creeping up very quickly, so I am currently refinancing my HELOC into a 5 year fixed rate HELOC at 3.5%. Using the HELOC strategy makes you look so much stronger in a tough market. Once the property was seasoned, I pulled a stand alone commercial loan and recharged the HELOC. Once my refi is in place I will be ready to go shopping again.
The HELOC strategy is really like a "self funded" short term bridge loan, that allows you to get into the property.
7 Reply
Kurt Hines
Investor · MI · Member since 2016 · 102 posts · 44 votes
8y
I'm looking at a similar strategy, and you need to consider what happens in a worst case scenario.
Your bank could decide at any point to cut off your HELOC. Consider the scenario where the real estate market goes down, and your home is no longer worth what it was when you got your HELOC. Your bank decides they don't like the risk, and don't let you borrow from it anymore. If you've been counting on the HELOC as your emergency fund, and then something else happens (possibly related to a recession), your emergency HELOC money is gone, and you don't have cash saved, because you were counting on the HELOC being there. Then something goes wrong at a rental, and you can't fix it, because you don't have reserves.
If your entire money strategy rests on the HELOC, and it disappears, you are in trouble. I keep 6 months of personal and rental reserves sitting in a bank account, so I know if disaster strikes, or I lose my job, I don't lose everything else. Better safe than sorry.
7 Reply
Lana Lee
Philadelphia, PA · Member since 2017 · 364 posts · 109 votes
8y
Originally posted by @Alex Corral:

@Lana Lee
I would love to have that deal. I checked with the CU you told me, but they don't lend in that my State.
Keep looking in your area .
1 Reply
Alex Corral
OP
Denver, CO · Member since 2017 · 142 posts · 104 votes
8y
Originally posted by @Arlen Chou:
@Alex Corral as some have pointed out, there are still tax advantages to a HELOC, you just need to document things more clearly so that the trail of money is more obvious. The key to this strategy is to find a competitive HELOC. My current HELOC is for over $1M on a 10 year draw at prime MINUS 1%. I pay down my loan at an accelerated pace by calculating what my monthly nut would be if I had a higher fixed rate mortgage and paying that amount vs what is actually due. The delta is applied to principle. If I need money in a pinch I can access it easily with the HELOC. With a traditional loan I would be behind the eight ball and potentially need to do a "cash out refi".
But rates are creeping up very quickly, so I am currently refinancing my HELOC into a 5 year fixed rate HELOC at 3.5%. Using the HELOC strategy makes you look so much stronger in a tough market. Once the property was seasoned, I pulled a stand alone commercial loan and recharged the HELOC. Once my refi is in place I will be ready to go shopping again.
The HELOC strategy is really like a "self funded" short term bridge loan, that allows you to get into the property.
Thanks for the info. I will keep looking. So far, the best I have found is prime minus 1.26, but only for 12 months. Then it is prime + .03 - .28 (depending on LTV).
I also found a CU that has a 5/1 arm at 4.0% up to 90 LTV. Considering that as well, but I feel like I need another 1-2 year cushion.
0 Reply
Tyler Kastelberg
Real Estate Technology · San Francisco, CA · Member since 2016 · 262 posts · 265 votes
8y
Alex: I like to use LOCs as equity for the purchase of real estate, then raise funds from equity investors to pay back the LOC. You can retain control of the property and lots of upside if you structure the buyout as a syndicate with a promote - similar to how hedge funds and private equity funds buy real estate.
2 Reply
James W.
Minneapolis, MN · Member since 2017 · 353 posts · 223 votes
8y
Originally posted by @Alex Corral:

@James W. That is odd. I've called about 15 banks & CU. All have 10 year draw & 20 year amortization.
Things must be changing then in the industry as a 5 year draw was pretty standard when I was auditing credit unions.
0 Reply
Tim B.
Flipper/Rehabber · Pensacola, FL · Member since 2017 · 33 posts · 24 votes
8y
So what about using a Heloc to fund the 3 deals then moving them to a portfolio loan or some other type of commercial loan to encompass the 3.
Then you would have the Heloc free for doing it again.
I'm assuming that the portfolio loan would not be of tax benefits though.
1 Reply
Dan Baker
Englewood, CO · Member since 2017 · 23 posts · 10 votes
8y
Originally posted by @Alex Corral:

Thanks for the info. I know the HELOC debate is still out, but from the research I've done, it seems that that type of loan will be paid off faster. So, even if the rate does increase, it will still be cheaper to pay it on a HELOC. There are tons of threads about it here on BP. Seems to be split though. Wish I had seen this sooner since Prime has not changed the last 10 years, until recently.
The monthly payment on your HELOC will be higher than the monthly payment of your loan if you did the refi. If you increase your monthly payment on the refi (to payoff additional equity each payment) you will be paying down the "loan" just as quickly as paying off your HELOC, but at a cheaper rate.
0 Reply
Derek Hubbard
Investor · Leesburg, VA · Member since 2017 · 4 posts · 2 votes
8y
+1 to the Cash-out Refi option over the HELOC
The interest rate will almost always be better. The main negative is that you will start making payments against the new balance of the loan as soon as the refi is completed and with a HELOC you aren't hit with the interest until you are ready to make a deal and perform a withdrawl.(minus some potential small servicing fee to the keep the HELOC account active).
However, if you already have some deals in mind to pursue or expect to find some in the near future then the refi should still be the better deal (especially considering current interest rates). It has already pointed out that you repay the refi early in the same way you would pay down the HELOC but you have more flexibility if something comes up since the payments would be lower.
0 Reply
Kiley N.
Honolulu, HI · Member since 2017 · 231 posts · 191 votes
8y
Hi @Alex Corral :
Great discussion above! I would add that the closing costs should not be forgotten. That money can essentially be considered prepaid interest (it's money you pay that goes to someone else). These costs increase the effective rate that you would be paying on the mortgage should you choose to go that route.
Going back to your original post, the key to your strategy appears to be the focusing all available cash flows on repayment of the HELOC. This can be effective if you are able to find a good HELOC promo rate and repay your balance within the fixed-rate period. You estimated 6 years to repay your first 3 properties which seems reasonable for a promo fixed-rate period. This will mitigate the risk of rising rates while still providing you liquidity on amounts repaid and you save on the closing costs. win-win-win.
Once your promotional period is up it will be up to you (as it is for each investor individually) if the liquidity of a variable-rate HELOC is worth the interest rate risk going forward. If all goes to plan, however, you will also have equity in 3 free and clear properties...
1 Reply
Jessica Roland
Investor · Atlantic, IA · Member since 2016 · 22 posts · 7 votes
8y
We took out a HELOC this summer for a fixer upper that we paid cash for. After it was rented, we did a cash out refinance with a conventional loan and paid it off. Interest rate and monthly payment is less than credit cards. Now we have that credit line available to use again!
2 Reply
Albert Bui
Lender · Bellevue WA & Orange County, CA · Member since 2013 · 2k+ posts · 1k+ votes
8y
Originally posted by @Joe Splitrock:

Originally posted by @Alex Corral:
Originally posted by @Joe Splitrock:

@Alex Corral there is lots of mis-informaiton about HELOC interest in the forums. I have participated in discussions around this and the split is between people who understand how interest works and people who don't.
Interest accrued on a HELOC and fixed rate mortgage is calculated the same and is based on the outstanding balance and interest rate. In other words, if I took out a HELOC for $100,000 at 4% and paid monthly even payments over 30 years, it would be the same as a 30 year fixed rate mortgage at 4%.
The only way to pay off the loan faster is by paying more principal. If you applied the same principal payments to a 30 year fixed rate mortgage as you did your HELOC, it would pay off just as fast. In the comparisons I have done, usually the HELOC takes longer and you pay more interest, because of the higher interest rate on the HELOC.
The advantage of the HELOC as a "savings account" is that all your capital goes immediately towards principal pay down. People find it easier than making extra principal payments on a mortgage. The other consideration is that once you make a principal payment to a mortgage, the cash is gone towards equity. With a HELOC you can just take the money back out if you need it.
I like your strategy of using the HELOC to make cash offers. In today's competitive environment, that gives you and advantage. I would refinance the properties into 30 year fixed rate mortgages to lock in low interest rates. Your HELOC is variable and the way the FED is raising rates, you will be stuck paying 1-2% more interest in a year or two. You are better off locking in the low fixed mortgage rates and making extra principal payments.
Hi Joe, I totally agree with you. I've read many threads and am about 9 pages in on that crazy long discussion you were in :)
I have been trying to be real careful about the different in interest. Seems odd, but I've been told that it is like credit card interest. I made an excel spreadsheet, and my calculations were better on the HELOC, but again, I'm not 100% sure. The main benefit I see, is being able to re-use that HELOC for a sudden repair, if needed. The CON, is that the rates are finally starting to creep, and with how the economy has been, I think it will keep rising. Tough choice.
Ahh yes, my favorite BP discussion of all time. The problem there was we were debating a changing argument. You can pay off a mortgage faster using a HELOC, but you can also pay off a fixed rate mortgage in the same time if you use the same principal payments. Usually when people compare the two, the difference is making extra payments on the HELOC and not making them on the fixed mortgage. Without seeing your spreadsheet, it is hard to say why your HELOC is coming out better. I can assure you if the interest amount and all the principal payments are the same, there is little difference. Both types of loans recalculate the interest as you pay down principal. If I recall there is a minor difference on when this occurs within the month, but it doesn't translate to anything significant in the end. It is discussed in the thread.
The only benefit is being is being able to re-use the HELOC. The disadvantage is a higher interest rate, which is a major concern in the coming years. The FED has stated they WILL keep raising rates. If it takes you years to pay this off, you could end up paying significantly more over time.
Here is another approach. Use the HELOC to purchase, then refinance into 30 year fixed rate. Every month, take all your extra cash and put it towards paying off one of the mortgages as an extra principal payment. If you need money, your HELOC is open with $0 balance on it. You can take advantage of low, fixed rates and have a ready line of credit. Best of both worlds.
Most HELOC's calculate interest on an average daily balance so they'll add up the end of day balances for 30 days and divide it by 30 so your interest factored by month could be marginally lower than a 30 year fixed.
A 30 year fixed calculates interest on the 1st day of the month for 360 months or intervals so if you make extra payments during the month there is no recalculation till the 1st of the next month. This causes a borrower to pay "compounded," interest but its the pros and cons we trade for a 30 year fixed term with fixed monthly payments.
Any one who has both mortgages can read their mortgage note to digest this, but also to test it in the real world by having both and making the same payment on both heloc and fixed loan assuming the same interest rate to see how the proportions of interest & principal differ.
The best method of interest calculation occurs on commercial lines or loans that calculate interest per day which is simple interest at its purest. There are very few products out there that do this besides commercial lines/loans or AIO - all in one loans from CMG financial on the residential side of things.
I took my own penfed FCU HELOC mortgage note to below which is a residential HELOC product based on average daily balance method versus a
PENTAGON Federal Credit Union - www.penfed.org - balance outstanding at the end of each day / total days in the month X (rate/12)
Commercial Mortgage Note - annual rate / 365 X daily ending balance = interest charged per day X total days in the month = monthly interest due
It may seem like trivial differences but small differences make profound differences over time. The above are differences bankers dont want you to know about (besides fractional reserve banking).
2 Reply
Rocky Griffin
Flipper/Rehabber · Edmond, OK · Member since 2016 · 209 posts · 107 votes
8y
I use my to buy a property cash and rehab. Once rehab is completed I then mortgage it, pay off my HELOC so its loaded and I can quickly pull the trigger on the next great deal.
3 Reply
Joe SplitrockPro Member
Moderator
Rental Property Investor · Sioux Falls, SD · Member since 2015 · 9k+ posts · 18k+ votes
8y
Originally posted by @Albert Bui:

Originally posted by @Joe Splitrock:
Originally posted by @Alex Corral:

Originally posted by @Joe Splitrock:
@Alex Corral there is lots of mis-informaiton about HELOC interest in the forums. I have participated in discussions around this and the split is between people who understand how interest works and people who don't.
Interest accrued on a HELOC and fixed rate mortgage is calculated the same and is based on the outstanding balance and interest rate. In other words, if I took out a HELOC for $100,000 at 4% and paid monthly even payments over 30 years, it would be the same as a 30 year fixed rate mortgage at 4%.
The only way to pay off the loan faster is by paying more principal. If you applied the same principal payments to a 30 year fixed rate mortgage as you did your HELOC, it would pay off just as fast. In the comparisons I have done, usually the HELOC takes longer and you pay more interest, because of the higher interest rate on the HELOC.
The advantage of the HELOC as a "savings account" is that all your capital goes immediately towards principal pay down. People find it easier than making extra principal payments on a mortgage. The other consideration is that once you make a principal payment to a mortgage, the cash is gone towards equity. With a HELOC you can just take the money back out if you need it.
I like your strategy of using the HELOC to make cash offers. In today's competitive environment, that gives you and advantage. I would refinance the properties into 30 year fixed rate mortgages to lock in low interest rates. Your HELOC is variable and the way the FED is raising rates, you will be stuck paying 1-2% more interest in a year or two. You are better off locking in the low fixed mortgage rates and making extra principal payments.
Hi Joe, I totally agree with you. I've read many threads and am about 9 pages in on that crazy long discussion you were in :)
I have been trying to be real careful about the different in interest. Seems odd, but I've been told that it is like credit card interest. I made an excel spreadsheet, and my calculations were better on the HELOC, but again, I'm not 100% sure. The main benefit I see, is being able to re-use that HELOC for a sudden repair, if needed. The CON, is that the rates are finally starting to creep, and with how the economy has been, I think it will keep rising. Tough choice.
Ahh yes, my favorite BP discussion of all time. The problem there was we were debating a changing argument. You can pay off a mortgage faster using a HELOC, but you can also pay off a fixed rate mortgage in the same time if you use the same principal payments. Usually when people compare the two, the difference is making extra payments on the HELOC and not making them on the fixed mortgage. Without seeing your spreadsheet, it is hard to say why your HELOC is coming out better. I can assure you if the interest amount and all the principal payments are the same, there is little difference. Both types of loans recalculate the interest as you pay down principal. If I recall there is a minor difference on when this occurs within the month, but it doesn't translate to anything significant in the end. It is discussed in the thread.
The only benefit is being is being able to re-use the HELOC. The disadvantage is a higher interest rate, which is a major concern in the coming years. The FED has stated they WILL keep raising rates. If it takes you years to pay this off, you could end up paying significantly more over time.
Here is another approach. Use the HELOC to purchase, then refinance into 30 year fixed rate. Every month, take all your extra cash and put it towards paying off one of the mortgages as an extra principal payment. If you need money, your HELOC is open with $0 balance on it. You can take advantage of low, fixed rates and have a ready line of credit. Best of both worlds.
Most HELOC's calculate interest on an average daily balance so they'll add up the end of day balances for 30 days and divide it by 30 so your interest factored by month could be marginally lower than a 30 year fixed.
A 30 year fixed calculates interest on the 1st day of the month for 360 months or intervals so if you make extra payments during the month there is no recalculation till the 1st of the next month. This causes a borrower to pay "compounded," interest but its the pros and cons we trade for a 30 year fixed term with fixed monthly payments.
Any one who has both mortgages can read their mortgage note to digest this, but also to test it in the real world by having both and making the same payment on both heloc and fixed loan assuming the same interest rate to see how the proportions of interest & principal differ.
The best method of interest calculation occurs on commercial lines or loans that calculate interest per day which is simple interest at its purest. There are very few products out there that do this besides commercial lines/loans or AIO - all in one loans from CMG financial on the residential side of things.
I took my own penfed FCU HELOC mortgage note to below which is a residential HELOC product based on average daily balance method versus a
PENTAGON Federal Credit Union - www.penfed.org - balance outstanding at the end of each day / total days in the month X (rate/12)
Commercial Mortgage Note - annual rate / 365 X daily ending balance = interest charged per day X total days in the month = monthly interest due
It may seem like trivial differences but small differences make profound differences over time. The above are differences bankers dont want you to know about (besides fractional reserve banking).
The HELOC recalculates daily because it is a line of credit, so the balance could increase at any time. Of course the lender wants to capture interest for any added principal. I have to make a correction on your statement, that a 30 year fixed recalculates based on 360 payments. It is actually a simple interest calculation of outstanding balance times annual rate divided by 12 months. So the difference is recalculating simple interest daily or monthly.
All things equal, this is going to be a trivial difference over a long period of time. The size of your extra principal payments is what makes the difference in how early you pay off any loan. Let's say you made a $500 extra payment on a HELOC and it hit one day into the month, so you capture 30 days worth of interest savings. Based on a 4% loan, 30 days worth of interest on $500 works out to roughly $1.64 saved. In this example if you paid $500 extra every month and timed just right, you could save $20 a year worth of interest.
Most any HELOC (minus introductory rates) is a higher interest rate than a fixed rate mortgage, so the extra points of interest makes a more significant difference over time. For example on a $100,000 loan, a fixed rate mortgage at 4% is $4000 worth of interest, versus 5% is $5000 interest. In this simple example, the extra point translates to $1000. The big concern right now is that variable rate loans will see regular rate increases, making it even worse a year or two from now.
The point that people need to understand is that interest rate and outstanding principal are the two biggest factors. Mortgage acceleration works due to extra principal payments. Keep your outstanding balances on the lowest rate, then make extra principal payments.
1 Reply
Albert Bui
Lender · Bellevue WA & Orange County, CA · Member since 2013 · 2k+ posts · 1k+ votes
8y
Originally posted by @Joe Splitrock:

Originally posted by @Albert Bui:
Originally posted by @Joe Splitrock:

Originally posted by @Alex Corral:
Originally posted by @Joe Splitrock:

@Alex Corral there is lots of mis-informaiton about HELOC interest in the forums. I have participated in discussions around this and the split is between people who understand how interest works and people who don't.
Interest accrued on a HELOC and fixed rate mortgage is calculated the same and is based on the outstanding balance and interest rate. In other words, if I took out a HELOC for $100,000 at 4% and paid monthly even payments over 30 years, it would be the same as a 30 year fixed rate mortgage at 4%.
The only way to pay off the loan faster is by paying more principal. If you applied the same principal payments to a 30 year fixed rate mortgage as you did your HELOC, it would pay off just as fast. In the comparisons I have done, usually the HELOC takes longer and you pay more interest, because of the higher interest rate on the HELOC.
The advantage of the HELOC as a "savings account" is that all your capital goes immediately towards principal pay down. People find it easier than making extra principal payments on a mortgage. The other consideration is that once you make a principal payment to a mortgage, the cash is gone towards equity. With a HELOC you can just take the money back out if you need it.
I like your strategy of using the HELOC to make cash offers. In today's competitive environment, that gives you and advantage. I would refinance the properties into 30 year fixed rate mortgages to lock in low interest rates. Your HELOC is variable and the way the FED is raising rates, you will be stuck paying 1-2% more interest in a year or two. You are better off locking in the low fixed mortgage rates and making extra principal payments.
Hi Joe, I totally agree with you. I've read many threads and am about 9 pages in on that crazy long discussion you were in :)
I have been trying to be real careful about the different in interest. Seems odd, but I've been told that it is like credit card interest. I made an excel spreadsheet, and my calculations were better on the HELOC, but again, I'm not 100% sure. The main benefit I see, is being able to re-use that HELOC for a sudden repair, if needed. The CON, is that the rates are finally starting to creep, and with how the economy has been, I think it will keep rising. Tough choice.
Ahh yes, my favorite BP discussion of all time. The problem there was we were debating a changing argument. You can pay off a mortgage faster using a HELOC, but you can also pay off a fixed rate mortgage in the same time if you use the same principal payments. Usually when people compare the two, the difference is making extra payments on the HELOC and not making them on the fixed mortgage. Without seeing your spreadsheet, it is hard to say why your HELOC is coming out better. I can assure you if the interest amount and all the principal payments are the same, there is little difference. Both types of loans recalculate the interest as you pay down principal. If I recall there is a minor difference on when this occurs within the month, but it doesn't translate to anything significant in the end. It is discussed in the thread.
The only benefit is being is being able to re-use the HELOC. The disadvantage is a higher interest rate, which is a major concern in the coming years. The FED has stated they WILL keep raising rates. If it takes you years to pay this off, you could end up paying significantly more over time.
Here is another approach. Use the HELOC to purchase, then refinance into 30 year fixed rate. Every month, take all your extra cash and put it towards paying off one of the mortgages as an extra principal payment. If you need money, your HELOC is open with $0 balance on it. You can take advantage of low, fixed rates and have a ready line of credit. Best of both worlds.
Most HELOC's calculate interest on an average daily balance so they'll add up the end of day balances for 30 days and divide it by 30 so your interest factored by month could be marginally lower than a 30 year fixed.
A 30 year fixed calculates interest on the 1st day of the month for 360 months or intervals so if you make extra payments during the month there is no recalculation till the 1st of the next month. This causes a borrower to pay "compounded," interest but its the pros and cons we trade for a 30 year fixed term with fixed monthly payments.
Any one who has both mortgages can read their mortgage note to digest this, but also to test it in the real world by having both and making the same payment on both heloc and fixed loan assuming the same interest rate to see how the proportions of interest & principal differ.
The best method of interest calculation occurs on commercial lines or loans that calculate interest per day which is simple interest at its purest. There are very few products out there that do this besides commercial lines/loans or AIO - all in one loans from CMG financial on the residential side of things.
I took my own penfed FCU HELOC mortgage note to below which is a residential HELOC product based on average daily balance method versus a
PENTAGON Federal Credit Union - www.penfed.org - balance outstanding at the end of each day / total days in the month X (rate/12)
Commercial Mortgage Note - annual rate / 365 X daily ending balance = interest charged per day X total days in the month = monthly interest due
It may seem like trivial differences but small differences make profound differences over time. The above are differences bankers dont want you to know about (besides fractional reserve banking).
The HELOC recalculates daily because it is a line of credit, so the balance could increase at any time. Of course the lender wants to capture interest for any added principal. I have to make a correction on your statement, that a 30 year fixed recalculates based on 360 payments. It is actually a simple interest calculation of outstanding balance times annual rate divided by 12 months. So the difference is recalculating simple interest daily or monthly.
All things equal, this is going to be a trivial difference over a long period of time. The size of your extra principal payments is what makes the difference in how early you pay off any loan. Let's say you made a $500 extra payment on a HELOC and it hit one day into the month, so you capture 30 days worth of interest savings. Based on a 4% loan, 30 days worth of interest on $500 works out to roughly $1.64 saved. In this example if you paid $500 extra every month and timed just right, you could save $20 a year worth of interest.
Most any HELOC (minus introductory rates) is a higher interest rate than a fixed rate mortgage, so the extra points of interest makes a more significant difference over time. For example on a $100,000 loan, a fixed rate mortgage at 4% is $4000 worth of interest, versus 5% is $5000 interest. In this simple example, the extra point translates to $1000. The big concern right now is that variable rate loans will see regular rate increases, making it even worse a year or two from now.
The point that people need to understand is that interest rate and outstanding principal are the two biggest factors. Mortgage acceleration works due to extra principal payments. Keep your outstanding balances on the lowest rate, then make extra principal payments.
It may be "Simple," interest on fixed loan, based on the initial balance at the onset of a month on the 1st but if a borrower paid extra principal after that date or in the middle of the month then they are paying a higher effective rate because instead of the interest being calculated on a lower balance after the principal contribution its still calculated off the higher initial balance from the 1st of the month.
Although it may seem small it could equate to tens of thousands of dollars over the life of the loan or more, because that extra interest difference from the calculation could have been redirected to reduce additional principal and now its being paid as "interest," and is lost. This is how "compound interest," term gets used because you're paying interest on interest indirectly and it compounds over time through out the 30 year fixed loan as amortization and interest recalc only occurs at the onset of each month.
0 Reply
Albert Bui
Lender · Bellevue WA & Orange County, CA · Member since 2013 · 2k+ posts · 1k+ votes
8y
Originally posted by @Rocky Griffin:

I use my to buy a property cash and rehab. Once rehab is completed I then mortgage it, pay off my HELOC so its loaded and I can quickly pull the trigger on the next great deal.
Yup as long as your ARV comes through on your appraisal post rehab you'll have enough to payoff all or most of your HELOC. The danger with this strategy is sometimes the investor miscalculates the ARV and ends up only being able to payoff a fraction of the line, but thats okay too.
0 Reply
Joe SplitrockPro Member
Moderator
Rental Property Investor · Sioux Falls, SD · Member since 2015 · 9k+ posts · 18k+ votes
8y
Originally posted by @Albert Bui:

Originally posted by @Joe Splitrock:
Originally posted by @Albert Bui:

Originally posted by @Joe Splitrock:
Originally posted by @Alex Corral:

Originally posted by @Joe Splitrock:
@Alex Corral there is lots of mis-informaiton about HELOC interest in the forums. I have participated in discussions around this and the split is between people who understand how interest works and people who don't.
Interest accrued on a HELOC and fixed rate mortgage is calculated the same and is based on the outstanding balance and interest rate. In other words, if I took out a HELOC for $100,000 at 4% and paid monthly even payments over 30 years, it would be the same as a 30 year fixed rate mortgage at 4%.
The only way to pay off the loan faster is by paying more principal. If you applied the same principal payments to a 30 year fixed rate mortgage as you did your HELOC, it would pay off just as fast. In the comparisons I have done, usually the HELOC takes longer and you pay more interest, because of the higher interest rate on the HELOC.
The advantage of the HELOC as a "savings account" is that all your capital goes immediately towards principal pay down. People find it easier than making extra principal payments on a mortgage. The other consideration is that once you make a principal payment to a mortgage, the cash is gone towards equity. With a HELOC you can just take the money back out if you need it.
I like your strategy of using the HELOC to make cash offers. In today's competitive environment, that gives you and advantage. I would refinance the properties into 30 year fixed rate mortgages to lock in low interest rates. Your HELOC is variable and the way the FED is raising rates, you will be stuck paying 1-2% more interest in a year or two. You are better off locking in the low fixed mortgage rates and making extra principal payments.
Hi Joe, I totally agree with you. I've read many threads and am about 9 pages in on that crazy long discussion you were in :)
I have been trying to be real careful about the different in interest. Seems odd, but I've been told that it is like credit card interest. I made an excel spreadsheet, and my calculations were better on the HELOC, but again, I'm not 100% sure. The main benefit I see, is being able to re-use that HELOC for a sudden repair, if needed. The CON, is that the rates are finally starting to creep, and with how the economy has been, I think it will keep rising. Tough choice.
Ahh yes, my favorite BP discussion of all time. The problem there was we were debating a changing argument. You can pay off a mortgage faster using a HELOC, but you can also pay off a fixed rate mortgage in the same time if you use the same principal payments. Usually when people compare the two, the difference is making extra payments on the HELOC and not making them on the fixed mortgage. Without seeing your spreadsheet, it is hard to say why your HELOC is coming out better. I can assure you if the interest amount and all the principal payments are the same, there is little difference. Both types of loans recalculate the interest as you pay down principal. If I recall there is a minor difference on when this occurs within the month, but it doesn't translate to anything significant in the end. It is discussed in the thread.
The only benefit is being is being able to re-use the HELOC. The disadvantage is a higher interest rate, which is a major concern in the coming years. The FED has stated they WILL keep raising rates. If it takes you years to pay this off, you could end up paying significantly more over time.
Here is another approach. Use the HELOC to purchase, then refinance into 30 year fixed rate. Every month, take all your extra cash and put it towards paying off one of the mortgages as an extra principal payment. If you need money, your HELOC is open with $0 balance on it. You can take advantage of low, fixed rates and have a ready line of credit. Best of both worlds.
Most HELOC's calculate interest on an average daily balance so they'll add up the end of day balances for 30 days and divide it by 30 so your interest factored by month could be marginally lower than a 30 year fixed.
A 30 year fixed calculates interest on the 1st day of the month for 360 months or intervals so if you make extra payments during the month there is no recalculation till the 1st of the next month. This causes a borrower to pay "compounded," interest but its the pros and cons we trade for a 30 year fixed term with fixed monthly payments.
Any one who has both mortgages can read their mortgage note to digest this, but also to test it in the real world by having both and making the same payment on both heloc and fixed loan assuming the same interest rate to see how the proportions of interest & principal differ.
The best method of interest calculation occurs on commercial lines or loans that calculate interest per day which is simple interest at its purest. There are very few products out there that do this besides commercial lines/loans or AIO - all in one loans from CMG financial on the residential side of things.
I took my own penfed FCU HELOC mortgage note to below which is a residential HELOC product based on average daily balance method versus a
PENTAGON Federal Credit Union - www.penfed.org - balance outstanding at the end of each day / total days in the month X (rate/12)
Commercial Mortgage Note - annual rate / 365 X daily ending balance = interest charged per day X total days in the month = monthly interest due
It may seem like trivial differences but small differences make profound differences over time. The above are differences bankers dont want you to know about (besides fractional reserve banking).
The HELOC recalculates daily because it is a line of credit, so the balance could increase at any time. Of course the lender wants to capture interest for any added principal. I have to make a correction on your statement, that a 30 year fixed recalculates based on 360 payments. It is actually a simple interest calculation of outstanding balance times annual rate divided by 12 months. So the difference is recalculating simple interest daily or monthly.
All things equal, this is going to be a trivial difference over a long period of time. The size of your extra principal payments is what makes the difference in how early you pay off any loan. Let's say you made a $500 extra payment on a HELOC and it hit one day into the month, so you capture 30 days worth of interest savings. Based on a 4% loan, 30 days worth of interest on $500 works out to roughly $1.64 saved. In this example if you paid $500 extra every month and timed just right, you could save $20 a year worth of interest.
Most any HELOC (minus introductory rates) is a higher interest rate than a fixed rate mortgage, so the extra points of interest makes a more significant difference over time. For example on a $100,000 loan, a fixed rate mortgage at 4% is $4000 worth of interest, versus 5% is $5000 interest. In this simple example, the extra point translates to $1000. The big concern right now is that variable rate loans will see regular rate increases, making it even worse a year or two from now.
The point that people need to understand is that interest rate and outstanding principal are the two biggest factors. Mortgage acceleration works due to extra principal payments. Keep your outstanding balances on the lowest rate, then make extra principal payments.
It may be "Simple," interest on fixed loan, based on the initial balance at the onset of a month on the 1st but if a borrower paid extra principal after that date or in the middle of the month then they are paying a higher effective rate because instead of the interest being calculated on a lower balance after the principal contribution its still calculated off the higher initial balance from the 1st of the month.
Although it may seem small it could equate to tens of thousands of dollars over the life of the loan or more, because that extra interest difference from the calculation could have been redirected to reduce additional principal and now its being paid as "interest," and is lost. This is how "compound interest," term gets used because you're paying interest on interest indirectly and it compounds over time through out the 30 year fixed loan as amortization and interest recalc only occurs at the onset of each month.
Tens of thousands of dollars is a ridiculous claim. In the example I gave with making a $500 timed payment, you could save $20 a year. Even if you double your extra principal payment to $1000, then you are saving $40 a year. There is no way that $40 compounds to $10,000 in savings. Let's say you carry over $40 in principal reduction, at 4% per year, that saves you $1.60 worth of interest.
0 Reply
Albert Bui
Lender · Bellevue WA & Orange County, CA · Member since 2013 · 2k+ posts · 1k+ votes
8y
Originally posted by @Joe Splitrock:

Originally posted by @Albert Bui:
Originally posted by @Joe Splitrock:

Originally posted by @Albert Bui:
Originally posted by @Joe Splitrock:

Originally posted by @Alex Corral:
Originally posted by @Joe Splitrock:

@Alex Corral there is lots of mis-informaiton about HELOC interest in the forums. I have participated in discussions around this and the split is between people who understand how interest works and people who don't.
Interest accrued on a HELOC and fixed rate mortgage is calculated the same and is based on the outstanding balance and interest rate. In other words, if I took out a HELOC for $100,000 at 4% and paid monthly even payments over 30 years, it would be the same as a 30 year fixed rate mortgage at 4%.
The only way to pay off the loan faster is by paying more principal. If you applied the same principal payments to a 30 year fixed rate mortgage as you did your HELOC, it would pay off just as fast. In the comparisons I have done, usually the HELOC takes longer and you pay more interest, because of the higher interest rate on the HELOC.
The advantage of the HELOC as a "savings account" is that all your capital goes immediately towards principal pay down. People find it easier than making extra principal payments on a mortgage. The other consideration is that once you make a principal payment to a mortgage, the cash is gone towards equity. With a HELOC you can just take the money back out if you need it.
I like your strategy of using the HELOC to make cash offers. In today's competitive environment, that gives you and advantage. I would refinance the properties into 30 year fixed rate mortgages to lock in low interest rates. Your HELOC is variable and the way the FED is raising rates, you will be stuck paying 1-2% more interest in a year or two. You are better off locking in the low fixed mortgage rates and making extra principal payments.
Hi Joe, I totally agree with you. I've read many threads and am about 9 pages in on that crazy long discussion you were in :)
I have been trying to be real careful about the different in interest. Seems odd, but I've been told that it is like credit card interest. I made an excel spreadsheet, and my calculations were better on the HELOC, but again, I'm not 100% sure. The main benefit I see, is being able to re-use that HELOC for a sudden repair, if needed. The CON, is that the rates are finally starting to creep, and with how the economy has been, I think it will keep rising. Tough choice.
Ahh yes, my favorite BP discussion of all time. The problem there was we were debating a changing argument. You can pay off a mortgage faster using a HELOC, but you can also pay off a fixed rate mortgage in the same time if you use the same principal payments. Usually when people compare the two, the difference is making extra payments on the HELOC and not making them on the fixed mortgage. Without seeing your spreadsheet, it is hard to say why your HELOC is coming out better. I can assure you if the interest amount and all the principal payments are the same, there is little difference. Both types of loans recalculate the interest as you pay down principal. If I recall there is a minor difference on when this occurs within the month, but it doesn't translate to anything significant in the end. It is discussed in the thread.
The only benefit is being is being able to re-use the HELOC. The disadvantage is a higher interest rate, which is a major concern in the coming years. The FED has stated they WILL keep raising rates. If it takes you years to pay this off, you could end up paying significantly more over time.
Here is another approach. Use the HELOC to purchase, then refinance into 30 year fixed rate. Every month, take all your extra cash and put it towards paying off one of the mortgages as an extra principal payment. If you need money, your HELOC is open with $0 balance on it. You can take advantage of low, fixed rates and have a ready line of credit. Best of both worlds.
Most HELOC's calculate interest on an average daily balance so they'll add up the end of day balances for 30 days and divide it by 30 so your interest factored by month could be marginally lower than a 30 year fixed.
A 30 year fixed calculates interest on the 1st day of the month for 360 months or intervals so if you make extra payments during the month there is no recalculation till the 1st of the next month. This causes a borrower to pay "compounded," interest but its the pros and cons we trade for a 30 year fixed term with fixed monthly payments.
Any one who has both mortgages can read their mortgage note to digest this, but also to test it in the real world by having both and making the same payment on both heloc and fixed loan assuming the same interest rate to see how the proportions of interest & principal differ.
The best method of interest calculation occurs on commercial lines or loans that calculate interest per day which is simple interest at its purest. There are very few products out there that do this besides commercial lines/loans or AIO - all in one loans from CMG financial on the residential side of things.
I took my own penfed FCU HELOC mortgage note to below which is a residential HELOC product based on average daily balance method versus a
PENTAGON Federal Credit Union - www.penfed.org - balance outstanding at the end of each day / total days in the month X (rate/12)
Commercial Mortgage Note - annual rate / 365 X daily ending balance = interest charged per day X total days in the month = monthly interest due
It may seem like trivial differences but small differences make profound differences over time. The above are differences bankers dont want you to know about (besides fractional reserve banking).
The HELOC recalculates daily because it is a line of credit, so the balance could increase at any time. Of course the lender wants to capture interest for any added principal. I have to make a correction on your statement, that a 30 year fixed recalculates based on 360 payments. It is actually a simple interest calculation of outstanding balance times annual rate divided by 12 months. So the difference is recalculating simple interest daily or monthly.
All things equal, this is going to be a trivial difference over a long period of time. The size of your extra principal payments is what makes the difference in how early you pay off any loan. Let's say you made a $500 extra payment on a HELOC and it hit one day into the month, so you capture 30 days worth of interest savings. Based on a 4% loan, 30 days worth of interest on $500 works out to roughly $1.64 saved. In this example if you paid $500 extra every month and timed just right, you could save $20 a year worth of interest.
Most any HELOC (minus introductory rates) is a higher interest rate than a fixed rate mortgage, so the extra points of interest makes a more significant difference over time. For example on a $100,000 loan, a fixed rate mortgage at 4% is $4000 worth of interest, versus 5% is $5000 interest. In this simple example, the extra point translates to $1000. The big concern right now is that variable rate loans will see regular rate increases, making it even worse a year or two from now.
The point that people need to understand is that interest rate and outstanding principal are the two biggest factors. Mortgage acceleration works due to extra principal payments. Keep your outstanding balances on the lowest rate, then make extra principal payments.
It may be "Simple," interest on fixed loan, based on the initial balance at the onset of a month on the 1st but if a borrower paid extra principal after that date or in the middle of the month then they are paying a higher effective rate because instead of the interest being calculated on a lower balance after the principal contribution its still calculated off the higher initial balance from the 1st of the month.
Although it may seem small it could equate to tens of thousands of dollars over the life of the loan or more, because that extra interest difference from the calculation could have been redirected to reduce additional principal and now its being paid as "interest," and is lost. This is how "compound interest," term gets used because you're paying interest on interest indirectly and it compounds over time through out the 30 year fixed loan as amortization and interest recalc only occurs at the onset of each month.
Tens of thousands of dollars is a ridiculous claim. In the example I gave with making a $500 timed payment, you could save $20 a year. Even if you double your extra principal payment to $1000, then you are saving $40 a year. There is no way that $40 compounds to $10,000 in savings. Let's say you carry over $40 in principal reduction, at 4% per year, that saves you $1.60 worth of interest.
Here is a smaller example of 200 extra per month, 400 extra principal per month, and 600 per month on a 600k purchase, 480k loan 80% LTV, average 4.50% interest rate on a 30 year fixed. The payments have 1.25% property tax and 75 per month insurance.
This is also with extra payments on a fixed loan. The results would but improved with a line of credit that can calculate interest daily.
Click Link to View the below Mortgage Analysis LIve
The total amount of interest savings is huge over a 30 year time span, definitely more than "tens of thousands," in column 3 below with extra 200 principal the interest savings over 30 years is already over 66,000. The 30 year fixed with no extra principal payment pays a total of $396,439.57 total interest over the 30 years as compared with $330,695.72 (with the 200 xtra prin ea. Mo.).
These results would be much faster if interest was calculated per day as compared to a monthly calc on this 30 year fixed.
0 Reply
Joe SplitrockPro Member
Moderator
Rental Property Investor · Sioux Falls, SD · Member since 2015 · 9k+ posts · 18k+ votes
8y
Originally posted by @Albert Bui:

Originally posted by @Joe Splitrock:
Originally posted by @Albert Bui:

Originally posted by @Joe Splitrock:
Originally posted by @Albert Bui:

Originally posted by @Joe Splitrock:
Originally posted by @Alex Corral:

Originally posted by @Joe Splitrock:
@Alex Corral there is lots of mis-informaiton about HELOC interest in the forums. I have participated in discussions around this and the split is between people who understand how interest works and people who don't.
Interest accrued on a HELOC and fixed rate mortgage is calculated the same and is based on the outstanding balance and interest rate. In other words, if I took out a HELOC for $100,000 at 4% and paid monthly even payments over 30 years, it would be the same as a 30 year fixed rate mortgage at 4%.
The only way to pay off the loan faster is by paying more principal. If you applied the same principal payments to a 30 year fixed rate mortgage as you did your HELOC, it would pay off just as fast. In the comparisons I have done, usually the HELOC takes longer and you pay more interest, because of the higher interest rate on the HELOC.
The advantage of the HELOC as a "savings account" is that all your capital goes immediately towards principal pay down. People find it easier than making extra principal payments on a mortgage. The other consideration is that once you make a principal payment to a mortgage, the cash is gone towards equity. With a HELOC you can just take the money back out if you need it.
I like your strategy of using the HELOC to make cash offers. In today's competitive environment, that gives you and advantage. I would refinance the properties into 30 year fixed rate mortgages to lock in low interest rates. Your HELOC is variable and the way the FED is raising rates, you will be stuck paying 1-2% more interest in a year or two. You are better off locking in the low fixed mortgage rates and making extra principal payments.
Hi Joe, I totally agree with you. I've read many threads and am about 9 pages in on that crazy long discussion you were in :)
I have been trying to be real careful about the different in interest. Seems odd, but I've been told that it is like credit card interest. I made an excel spreadsheet, and my calculations were better on the HELOC, but again, I'm not 100% sure. The main benefit I see, is being able to re-use that HELOC for a sudden repair, if needed. The CON, is that the rates are finally starting to creep, and with how the economy has been, I think it will keep rising. Tough choice.
Ahh yes, my favorite BP discussion of all time. The problem there was we were debating a changing argument. You can pay off a mortgage faster using a HELOC, but you can also pay off a fixed rate mortgage in the same time if you use the same principal payments. Usually when people compare the two, the difference is making extra payments on the HELOC and not making them on the fixed mortgage. Without seeing your spreadsheet, it is hard to say why your HELOC is coming out better. I can assure you if the interest amount and all the principal payments are the same, there is little difference. Both types of loans recalculate the interest as you pay down principal. If I recall there is a minor difference on when this occurs within the month, but it doesn't translate to anything significant in the end. It is discussed in the thread.
The only benefit is being is being able to re-use the HELOC. The disadvantage is a higher interest rate, which is a major concern in the coming years. The FED has stated they WILL keep raising rates. If it takes you years to pay this off, you could end up paying significantly more over time.
Here is another approach. Use the HELOC to purchase, then refinance into 30 year fixed rate. Every month, take all your extra cash and put it towards paying off one of the mortgages as an extra principal payment. If you need money, your HELOC is open with $0 balance on it. You can take advantage of low, fixed rates and have a ready line of credit. Best of both worlds.
Most HELOC's calculate interest on an average daily balance so they'll add up the end of day balances for 30 days and divide it by 30 so your interest factored by month could be marginally lower than a 30 year fixed.
A 30 year fixed calculates interest on the 1st day of the month for 360 months or intervals so if you make extra payments during the month there is no recalculation till the 1st of the next month. This causes a borrower to pay "compounded," interest but its the pros and cons we trade for a 30 year fixed term with fixed monthly payments.
Any one who has both mortgages can read their mortgage note to digest this, but also to test it in the real world by having both and making the same payment on both heloc and fixed loan assuming the same interest rate to see how the proportions of interest & principal differ.
The best method of interest calculation occurs on commercial lines or loans that calculate interest per day which is simple interest at its purest. There are very few products out there that do this besides commercial lines/loans or AIO - all in one loans from CMG financial on the residential side of things.
I took my own penfed FCU HELOC mortgage note to below which is a residential HELOC product based on average daily balance method versus a
PENTAGON Federal Credit Union - www.penfed.org - balance outstanding at the end of each day / total days in the month X (rate/12)
Commercial Mortgage Note - annual rate / 365 X daily ending balance = interest charged per day X total days in the month = monthly interest due
It may seem like trivial differences but small differences make profound differences over time. The above are differences bankers dont want you to know about (besides fractional reserve banking).
The HELOC recalculates daily because it is a line of credit, so the balance could increase at any time. Of course the lender wants to capture interest for any added principal. I have to make a correction on your statement, that a 30 year fixed recalculates based on 360 payments. It is actually a simple interest calculation of outstanding balance times annual rate divided by 12 months. So the difference is recalculating simple interest daily or monthly.
All things equal, this is going to be a trivial difference over a long period of time. The size of your extra principal payments is what makes the difference in how early you pay off any loan. Let's say you made a $500 extra payment on a HELOC and it hit one day into the month, so you capture 30 days worth of interest savings. Based on a 4% loan, 30 days worth of interest on $500 works out to roughly $1.64 saved. In this example if you paid $500 extra every month and timed just right, you could save $20 a year worth of interest.
Most any HELOC (minus introductory rates) is a higher interest rate than a fixed rate mortgage, so the extra points of interest makes a more significant difference over time. For example on a $100,000 loan, a fixed rate mortgage at 4% is $4000 worth of interest, versus 5% is $5000 interest. In this simple example, the extra point translates to $1000. The big concern right now is that variable rate loans will see regular rate increases, making it even worse a year or two from now.
The point that people need to understand is that interest rate and outstanding principal are the two biggest factors. Mortgage acceleration works due to extra principal payments. Keep your outstanding balances on the lowest rate, then make extra principal payments.
It may be "Simple," interest on fixed loan, based on the initial balance at the onset of a month on the 1st but if a borrower paid extra principal after that date or in the middle of the month then they are paying a higher effective rate because instead of the interest being calculated on a lower balance after the principal contribution its still calculated off the higher initial balance from the 1st of the month.
Although it may seem small it could equate to tens of thousands of dollars over the life of the loan or more, because that extra interest difference from the calculation could have been redirected to reduce additional principal and now its being paid as "interest," and is lost. This is how "compound interest," term gets used because you're paying interest on interest indirectly and it compounds over time through out the 30 year fixed loan as amortization and interest recalc only occurs at the onset of each month.
Tens of thousands of dollars is a ridiculous claim. In the example I gave with making a $500 timed payment, you could save $20 a year. Even if you double your extra principal payment to $1000, then you are saving $40 a year. There is no way that $40 compounds to $10,000 in savings. Let's say you carry over $40 in principal reduction, at 4% per year, that saves you $1.60 worth of interest.
Here is a smaller example of 200 extra per month, 400 extra principal per month, and 600 per month on a 600k purchase, 480k loan 80% LTV, average 4.50% interest rate on a 30 year fixed. The payments have 1.25% property tax and 75 per month insurance.
This is also with extra payments on a fixed loan. The results would but improved with a line of credit that can calculate interest daily.
Click Link to View the below Mortgage Analysis LIve
The total amount of interest savings is huge over a 30 year time span, definitely more than "tens of thousands," in column 3 below with extra 200 principal the interest savings over 30 years is already over 66,000. The 30 year fixed with no extra principal payment pays a total of $396,439.57 total interest over the 30 years as compared with $330,695.72 (with the 200 xtra prin ea. Mo.).
These results would be much faster if interest was calculated per day as compared to a monthly calc on this 30 year fixed.
Our debate was whether paying extra principal on a fixed rate mortgage versus paying it on a HELOC would save tens of thousands of dollars. You claim that the daily interest calculation on the HELOC saves you tens of thousands. I claimed that paying extra principal on a fixed rate or HELOC works out about the same.
Your example proves my point. It shows paying extra principal on a fixed rate mortgage saves interest, which is what I already stated several times. The HELOC is not what causes you to save interest. It is the extra principal payments.
Using your example, if the HELOC had identical interest rate and identical extra principal payments and you timed the HELOC payments just right, you could save a maximum of $8 per year worth of interest. Your claim of saving "tens of thousands" due to how a HELOC calculates interest is incorrect. You could potentially save $200 over the life of the loan. That assumes you time the payments the day after the monthly interest recalculation would have occurred on your fixed rate mortgage. Most likely the HELOC is a higher interest rate, so you end up paying thousands more.
3 Reply
Steve N.
Financial Advisor · Greater Boston · Member since 2018 · 8 posts · 3 votes
8y
I know this is a 6 month old+ thread, but if you can find an interest only HELOC, the strategy of using a heloc might be better. Interest is computed on a daily basis, so a 200k ... lets say 4.25% (Prime minus .75) = under $700/month going towards interest.

A 200K 30 year mortgage will have a higher interest to principal payment ratio!

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DeShaun Sellers
Real Estate Broker · Raleigh, NC · Member since 2016 · 23 posts · 5 votes
8y
@David W. Is the HELOC in your personal name? If so does that affect your business filings since you are putting the rental income in the HELOC account?
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