Use HELOC to paydown mortgage fast

415 Replies

Hi Joe,

Personally, I've never heard about HELOC being used in this way. Usually, HELOC rate is higher that convention loans thus simple math just doesn't work out (e.g. getting 100K @5% to pay down primary mortgage @3.75%). Would you mind sharing high-level details about the method you mentioned?

As far as I understand the most common use case for HELOC is revolving line of credit for large purchases or renovation projects. In my case we were able to get a 80/10/10 piggy-back mortgage utilizing HELOC to avoid having PMI payments with only 10% down for our primary residence: interest of HELOC was comparable with PMI payment but had a small benefit being tax-deductable.

Regards,
Sergey

Traditional mortgage have amortization schedule, so for the early years of the mortgage payment, a large chunk of it will be paid to the interest. If you keep paying the mortgage for 30 years, you will end up paying at least 2 homes. The solution to that is to keep the daily balance of the mortgage as low as possible. By using HELOC, you would withdrawal from it to pay down a portion of the mortgage. And you will deposit your whole income to the HELOC and you will withdrawal expenses from HELOC when needed. Since the income stays in HELOC for most of the time, the balance of it stays low and the interest will be low(based on average daily balance). You will repeat these steps once the HELOC balance is back to zero. If you google this topic i am sure you can find the detail of it.

It's a dumb idea that pops up from time to time from some BS guru types. The basic reality is.....instead of using your extra Monday each month to pay back a heloc loan you borrowed to pay down your mortgage.....simply use that extra money each month to directly pay down your mortgage. All the other hype about simple verses compounded interest gobbledygook is just total BS.

So there is no math support behind it? They make it sound like even you don't pay extra every month. The lower average daily balance will keep the interest low.

Okay, let's say you have a $100k Mtg loan.  You borrow $20k on a heloc, which you pay on your Mtg, giving you a balance now of $80k, but you now owe $20k on a heloc loan.  You have to keep to making your monthly Mtg payments just as before. So, where does the money come from to pay back the $20k heloc  loan every month?  Those monthly heloc payments are your "extra payments".....you can simply pay that amount instead as extra toward your Mtg.

I agree with @Wayne Brooks .  Every time I hear this strategy, I'm like "What? That makes no sense."  I first heard about it on a podcast and even the person who brought it up couldn't explain it so it made any sense. 

I also heard about this a few months ago. I was excited at first, but when I ran some projections, it only very minimally helped in terms of quicker mortgage pay down. If anyone has some math on this showing it being successful, I would love to take a look. I'd really like this strategy to work, my math just doesn't support it. 

Thank you for everyone's input, it's great to have a community to ask this type of question.

Let's look beyond the mortgage and compare the 2 ways to pay down debt.

1. deposit cashflow into check account and pay debt monthly when it's due.

2. replace the debt with line of credit, deposit cashflow to LOC and withdrawal expenses when needed

which way will cost less interest? in the business world, i doubt a company will "park" they cash in the bank earning nothing while paying their debt with interest. there has to be a smart way to pay down debt.

@Joe Au I can tell you personally that it works. There is a book out there called "how to own your home years sooner without making any extra payments". My HELOC is prime +0 with a floor of 3.99. It worked tremendously and I was on pace to pay off my 240k 30 year mortgage in 9 years not changing anything other than the way I held money. By doing this one time I saved about 25k in interest payments over the course of the loan. If you look at an amortization schedule and run the numbers the interest is acquired daily so you can compound it very fast and the EXTRA PAYMENT is the same as the daily interest you save if not less from the prior amount owed. I saved about 20.00 a month including the payment, and that will increase x2 every time you due the 10k. So that is a squash/ gain unless your HELOC interest rates rise then there is a breaking point. Make sure you do your due diligence. However the larger savings was in the amortization schedule that you knocked off many payments to your schedule. You will need a good bonus points credit card and place everything on that and pay it off every month in full, at the last possible moment to leverage all of your compounding money. It worked fantastic however I realized that this is a horrible idea as you will not have any savings because all of your money is tied up in home equity. If they called the note, your screwed. Also I would loose a huge tax right off and being self employed I need all the write offs. Instead I would recommend using your HELOC to purchase more real estate that cash flows increase your net worth and pay it off even faster and repeating buying more property when you can. I would look at the option of using it to buy another Primary and turning your current one into a rental or buying multi family to cash flow. Make sure that you keep a 6 month savings plan minimum because HELOC's have historically been called in the past causing many foreclosures. best of luck

I'm familiar with this strategy, and it hinges upon the assumption that your income exceeds your expenses. It then just applies any excess cashflow above your actual expenses to principal paydown. So it does work, in theory, but a better method is to just manage your cashflows and apply excess cashflow to the principal on your mortgage. This way you're not using debt to payoff debt - you're paying off debt with surplus cashflow. This is all assuming that your HELOC and mortgage are the same rate. If you're currently cashflow neutral or negative, the payoff strategy with a HELOC will not work... so again, it hinges on being cashflow positive/living beneath your means.

Here's another way to look at it...

Let's say you have a HELOC and a 30-year fixed 1st mortgage.

Take the entire available balance of your HELOC and apply it to your first. Then, pay down the HELOC while keeping up your payments on the 1st.

Everytime you get a big chunk available in your HELOC, throw it at the 1st.

Why it works:

The 1st mortgage is amortized. That means the early payments are mostly interest while the principal balance is high. The payment is fixed and not dependent on the balance owing - the payment always stays the same unless the interest rate adjusts. (Yes, this works for ARM's, also.)

The HELOC, on the other hand, is like any other revolving credit. The payment is determined by the balance owing or the average daily balance - check the terms of your HELOC to determine what it is in your specific case - plus the interest on that balance for the payment period.

If you can manage your HELOC payments so you're throwing big chunks at your 1st on a regular schedule you'll payoff your 1st much faster than making double payments or any of that.

I don't have the numbers or the charts right at hand, but yes - using this technique, you CAN payoff a 30-year fixed in as little as seven years ... nine to ten is more likely, however.

Note, however, that every time you take a big chunk out on your HELOC your credit will take a hit: the spike in utilization will lower your score and impact your credit profile. Sorry - no free rides.

David J Dachtera

@David Dachtera - when you simply transfer debt from a mortgage to a HELOC, although you do pay less interest on the HELOC itself, you have negative amortization simultaneously occurring on the amortized loan (aka "capitalization"), so your principal grows and you accrue interest on the new, larger balance. It turns out that the savings you achieve on the HELOC will be equally offset by the negative amortization/capitalization occurring on the amortized loan. And this is due to the fact that 5% of $1 is 5 cents regardless of whether it's simple or amortized interest. Simply changing the compounding interval from monthly accrual (amortized loan) to average daily balance (HELOC) doesn't affect the amount of interest you pay, assuming you make payments on a monthly basis.

Amortization is just a term to describe how a series of future payments are calculated so that they are equal throughout the loan life, accounting for both principal and interest. 

One way that you can legitimately save (a tiny bit of) money with a HELOC is to make weekly, biweekly, or bimonthly payments. For example, assume you have a $10,000 balance @ 5%:

On your amortized loan, in one month you will accrue: $10,000 * 0.05/12 = $41.67 in interest, so if you made a $500 payment, your new total balance would be $9,541.67

But if you make two $250 payments in a month on your HELOC, you're average daily balance over the month would be: ($9,750 * 0.05 * (30.42/365) = $40.63 in interest, so your end of month balance after both payments would be $9,540.63. So you can save $1.04 per month by paying bimonthly on a HELOC vs. monthly on an amortized loan, making the same total monthly payment.

Since a dollar accrues interest at the same rate regardless of interest type, there is no mathematical way to payoff a loan quicker by simply transferring a balance. The only possible way to payoff a loan quicker is to pay a larger amount overall, or get a better interest rate. Simply shuffling debt while making the same net payment will result in the same payoff time.

@Eric Jones ,

I think you got it backwards...

The point is to reduce the interest you pay on the 1st mortgage, not the HELOC.

You pay down the HELOC while continuing your payments on the first. Then, when there's a lot of money available on the HELOC, you take it and apply it to the 1st.

No negative amortization is possible. You also cannot take a draw against an amortized loan: you can make payments against it, but you cannot draw money out like you can with a line of credit (HELOC).

HELOCs aren't amortized - they're revolving credit. You're still paying interest on what ever the balance is, but it's less interest overall than it would be with the 1st alone. It's just compound interest, same as your credit cards (average daily balance times the monthly periodic rate (or some similar formula - check the terms of your HELOC) plus 1/120th or some similar fraction of the principal balance to arrive at the monthly payment).

Also, check your definition of "amortization". Translated from the French root, you are literally "killing" the principal balance (or, the payment is killing you - depends how you look at it). Early on, the payments you make are mostly interest. As the principal balance is reduced, more of the payment gets applied to the principal balance. That is (and you can verify this with your amortization schedule from the bank when your loan originated), the interest and principal portions of the payment as applied are inversely proportional. The formula you gave is for one month's interest on a NON-amortized loan.

@David Dachtera - Thanks for the response David. 

The scenario that you're describing is one where you're essentially just prepaying the mortgage. So you're making your standard monthly mortgage payment, while simultaneously making occasional lump sum prepayments via the HELOC. Of course that will rapidly payoff your mortgage - you're prepaying! But I think the original question had to do with making just the standard payments - @Joe Au : "They make it sound like you don't have to pay extra every month". The question implies that simply trasferring debt from an amortized loan to a HELOC will result in a quicker payoff, assuming you're making the same payments on both, and at monthly intervals. Which is not the case...

The HELOC payoff schemes that I think Joe's referring to typically work where you make a lump sum payment to your mortgage via your HELOC. You then stop making payments on the mortgage, and dump all of your income as payments towards the HELOC. For your expenses, you pay those with the HELOC. During this time, your mortgage is accruing interest and it's capitalizing via negative amortization. Assuming you're cashflow positive, you will paydown the mortgage faster, but that's only because the excess cashflow is essentially just prepaying. It's mathematically the same as prepaying.

Lastly, the formulas are all correct. Amortization affects how the PAYMENT is calculated, not the interest. Interest is ALWAYS calculated as: Loan Balance * Interest Rate / compounding periods (n). The only difference between an amortized loan and a HELOC is how the Loan Balance portion of the equation is calculated - for HELOCs it's based on the avg daily balance, and for amortized loans it's the ending balance from the previous month after payments were applied. The reason that amortized loans are "front loaded" with interest is because the balance is high and it's accruing interest rapidly. There's nothing magical about amortization - the key to beating amortization is to prepay, not shuffling debt around while still paying the same amount.

In order to do an apple to apple comparison, you will have to take out a first lien HELOC to replace the traditional mortgage. That way you won't have to pay the lump sum from HELOC and make the regular mortgage payment.

Let's say traditional mortgage of 100K @ 5%, the first's month payment will be $536.82 ([email protected][email protected]).

For HELOC, assume your income is deposited at the beginning of the month for $5K and withdrawal expenses($4,463.18) at the last day of the month. Your net payment to HELOC is still $536.82. But the interest is actually $404.04 due to a lower average daily balance.

I checked the math and you're exactly right. So you end up saving $12.63 the first month, due to the timing of the payments, which effectively reduced the average daily balance from $100,000 to $95,143.97. So you're paying interest on $95,143.97 instead of on $100,000. Assuming you'd continue to accrue monthly savings of $12.63 every month (which you wouldn't, since the balance and therefore interest accrual is dropping each month), you're payoff term would be 28.46 years instead of 30 years - mathematically the same as applying a $12.63 prepayment each month on the amortized loan. In reality, I'd be surprised if it knocked a year off the mortgage term. 

The formula I mentioned above applies here - what has changed isn't how the INTEREST is calculated, it's how the interest-bearing BALANCE is calculated.

The guys I've heard promoting this method claim you can get payoffs of only 8-10 yrs, which is clearly not the case. This can only happen if you have a lot of surplus cashflow/prepayments that gets applied to the HELOC each month. So you can achieve a very small financial savings due to how the average daily balance is calculated on a HELOC... but would you rather tie up your HELOC to save $12.63 in interest a month, or use those funds to make more profitable investments?

@Eric Jones ,

You're still confused on payment calculations.

For a fixed-rate amortized loan, the payment is calculated exactly once - at inception. For an adjustable rate loan, the payment is calculated at inception and again at every rate adjustment. What changes in every period (usually a month) is how much of the payment is applied to the principal and how much to the interest. The payment amount remains fixed until the next rate adjustment (for adjustable rate loans).

Likewise for installment loans. They may or may not be amortized and the interest rate is typically fixed.

For revolving credit, the formula is usually found on the back of your monthly statement, though not in its entirety. As explained earlier, it will be some variation of this: average daily balance times the monthly periodic rate (or some similar formula - check the terms of your HELOC) plus 1/120th or some similar fraction of the principal balance to arrive at the monthly payment (a.k.a. compound interest).

Ask your CPA or other financial professional to review it with you.

Also, talk to someone who fully understands the mortgage acceleration strategy. It absolutely DOES work and this can be proven mathematically. That person will explain the math to you and show you where you're confusing yourself.

Here's a video you can review which explains it including all the numbers and illustrative graphics. It's an hour and 35 minutes and the host's first language is not English - he's Hawaiian. It's not exciting or entertaining, but it does explain the strategy.

@David Dachtera

Again, I'm not talking at all about PAYMENT calculations. I'm talking about INTEREST calculations. I agree that payments are calculated differently between an amortized loan and a HELOC. That's not the topic of discussion - we're talking about saving INTEREST using a HELOC payoff strategy versus a traditional monthly payment strategy. You're misunderstanding my main message, which is that the interest savings are miniscule, but there are some very minute savings due to the fact that you can slightly lower your average daily balance on a HELOC using the method described above.

To demonstrate this, if you have a $100K balance amortized over 360 payments @ 5% your monthly payments are $536.82. For payment #1, $416.67 goes to interest and $120.15 goes to principal. 

If you instead have a $100k balance on your HELOC @ 5%, and you make the same $536.82 payment as you did above (apples to apples), you will get the same breakdown of interest and principal (assuming you make a single monthly payment at the end of the month). The fact that your minimum PAYMENT on the HELOC might be much less (1/120th like you mentioned, for example) than your minimum payment on the amortized loan is totally irrelevant. Point is, they both accrue interest at the same rate, regardless of how your minimum payment is calculated. Make sense?

@Eric Jones ,

No, it doesn't make sense, and the numbers prove it.

I'll again invite you to review the video.

An interest savings in excess of five figures for a 30-year loan is HARDLY miniscule!

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