Use HELOC to paydown mortgage fast

415 Replies

Originally posted by @Joshua Smith :
Originally posted by @Chris May:
Originally posted by @Joshua Smith:
Originally posted by @Brent Coombs:

@Joshua Smith, "... In the first year of this hypothetical $165,000 / 4.5% loan we've been talking about - when you're whittling away at that first $10,000 - around 74% of your money goes toward interest. When you're paying down the $10,000 on the HELOC about 4-5% of your money is going toward interest...."

And THAT is the major point of the discussion. You can't really compare the HELOC interest RATE to the mortgage interest RATE (APR) because the real key is the AMOUNT of interest paid over time! The point is not how much the mortgage APR is, it is what the ACTUAL interest rate is in the early days of the loan! As you have repeatedly mentioned Joshua, the true "interest rate" in year one is much, much higher than the nominal APR; in this case it is 74%, not 4.5%. Quite a difference! Everyone just skips over this tiny detail, and instead, wants to steer the discussion toward the APR of the mortgage, and then argue about how that compares to the HELOC rate! Instead, the argument should be centered on HOW MANY DOLLARS IN INTEREST IS AVOIDED OVER THE LIFE OF THE MORTGAGE.

The other major point is this. Yes, you could take $10K from your checking account and slam it down on the mortgage to achieve a similar result. HOWEVER, 

(a) many people would rather preserve their checking account "cushion" instead of having it applied to the mortgage where it cannot be "retrieved" if needed later. By using HELOC funds instead, or even a zero-percent credit card advance with a 4% transaction fee, they are effectively using the CREDITOR's resources instead of their own money to accelerate mortgage loan payoff (at a "cost" of a few hundred dollars per year). That's another "tiny detail" everyone keeps ignoring. You are using "someone else's money" to accelerate mortgage paydown, not your own. And...

(b), if this method is used year after year, then $10K chunks of money NEVER have to come out of anyone's checking or savings account, because they are effectively using the creditor's funds while repaying them back over the course of a year using this "Velocity Banking" strategy. 

(c) It does take major discipline for people to place all of their income into the HELOC or line of credit while ensuring it exceeds their expenses by at least $1,000 per month in order to pay back the $10K within a year. If people cannot budget themselves to do this, the strategy explodes in their face.....

Originally posted by @Chris May:

Originally posted by @Joshua Smith :

Originally posted by @Brent Coombs:

@Joshua Smith, "... In the first year of this hypothetical $165,000 / 4.5% loan we've been talking about - when you're whittling away at that first $10,000 - around 74% of your money goes toward interest. When you're paying down the $10,000 on the HELOC about 4-5% of your money is going toward interest...."

And THAT is the major point of the discussion. You can't really compare the HELOC interest RATE to the mortgage interest RATE (APR) because the real key is the AMOUNT of interest paid over time! The point is not how much the mortgage APR is, it is what the ACTUAL interest rate is in the early days of the loan! As you have repeatedly mentioned Joshua, the true "interest rate" in year one is much, much higher than the nominal APR; in this case it is 74%, not 4.5%. Quite a difference! Everyone just skips over this tiny detail, and instead, wants to steer the discussion toward the APR of the mortgage, and then argue about how that compares to the HELOC rate! Instead, the argument should be centered on HOW MANY DOLLARS IN INTEREST IS AVOIDED OVER THE LIFE OF THE MORTGAGE.

The other major point is this. Yes, you could take $10K from your checking account and slam it down on the mortgage to achieve a similar result. HOWEVER,

(a) many people would rather preserve their checking account "cushion" instead of having it applied to the mortgage where it cannot be "retrieved" if needed later. By using HELOC funds instead, or even a zero-percent credit card advance with a 4% transaction fee, they are effectively using the CREDITOR's resources instead of their own money to accelerate mortgage loan payoff (at a "cost" of a few hundred dollars per year). That's another "tiny detail" everyone keeps ignoring. You are using "someone else's money" to accelerate mortgage paydown, not your own. And...

(b), if this method is used year after year, then $10K chunks of money NEVER have to come out of anyone's checking or savings account, because they are effectively using the creditor's funds while repaying them back over the course of a year using this "Velocity Banking" strategy.

(c) It does take major discipline for people to place all of their income into the HELOC or line of credit while ensuring it exceeds their expenses by at least $1,000 per month in order to pay back the $10K within a year. If people cannot budget themselves to do this, the strategy explodes in their face.....

Originally posted by @Gary Floring :

Originally posted by @Chris May:

Originally posted by @Joshua Smith:

Originally posted by @Brent Coombs:

@Joshua Smith, "... In the first year of this hypothetical $165,000 / 4.5% loan we've been talking about - when you're whittling away at that first $10,000 - around 74% of your money goes toward interest. When you're paying down the $10,000 on the HELOC about 4-5% of your money is going toward interest...."

And THAT is the major point of the discussion. You can't really compare the HELOC interest RATE to the mortgage interest RATE (APR) because the real key is the AMOUNT of interest paid over time! The point is not how much the mortgage APR is, it is what the ACTUAL interest rate is in the early days of the loan! As you have repeatedly mentioned Joshua, the true "interest rate" in year one is much, much higher than the nominal APR; in this case it is 74%, not 4.5%. Quite a difference! Everyone just skips over this tiny detail, and instead, wants to steer the discussion toward the APR of the mortgage, and then argue about how that compares to the HELOC rate! Instead, the argument should be centered on HOW MANY DOLLARS IN INTEREST IS AVOIDED OVER THE LIFE OF THE MORTGAGE.

The other major point is this. Yes, you could take $10K from your checking account and slam it down on the mortgage to achieve a similar result. HOWEVER,

(a) many people would rather preserve their checking account "cushion" instead of having it applied to the mortgage where it cannot be "retrieved" if needed later. By using HELOC funds instead, or even a zero-percent credit card advance with a 4% transaction fee, they are effectively using the CREDITOR's resources instead of their own money to accelerate mortgage loan payoff (at a "cost" of a few hundred dollars per year). That's another "tiny detail" everyone keeps ignoring. You are using "someone else's money" to accelerate mortgage paydown, not your own. And...

(b), if this method is used year after year, then $10K chunks of money NEVER have to come out of anyone's checking or savings account, because they are effectively using the creditor's funds while repaying them back over the course of a year using this "Velocity Banking" strategy.

(c) It does take major discipline for people to place all of their income into the HELOC or line of credit while ensuring it exceeds their expenses by at least $1,000 per month in order to pay back the $10K within a year. If people cannot budget themselves to do this, the strategy explodes in their face.....

Gary, I don't know why my name appeared in your quotes above. I can only assume that you removed any part of my post that you didn't want repeated here. But repeat it I will anyway: It's only YOUR extra income that gets to pay off your mortgage early! ie. You are not using "someone else's money to accelerate mortgage paydown"! (That only comes about if you sub-let your primary at the same time!)

I do agree that "if people cannot budget themselves to do this, the strategy explodes in their face".

But I also wrote: many/most mortgage holders do not have the luxury of "extra income"!...

Brent,

If a mortgage holder was "house rich but cash poor" they might have some usable equity in their property but nothing in their savings account (sad, but there ARE people who live paycheck to paycheck!).  

In that case, wouldn't they be using "someone else's money" if they took a $10,000 from a line of credit to place onto the mortgage? Yes, they would have to pay it back over the next 12 months from their ongoing income at the rate of almost $1,000 per month, but they would have already avoided tens of thousands of dollars in interest and years of time from their mortgage, correct? 

Then they simply lather, rinse, repeat, and the continue to use another $10,000 from a line of credit each year until its paid off, never having extra funds in their savings account.

Let me know where you agree or disagree with the points above.... Thanks

Two reasons:  

1. By using a line of credit, they would slam down the mortgage balance immediately by a large amount, thus avoiding tens of thousands of dollars in interest AND years from the amortization schedule, the cost of servicing the LOC could be nominal, like $300 or $400. They wouldn't be waiting a whole year to slowly pay down the mortgage by $1,000 per month.

2. By repeating this strategy year after year, they would greatly accelerate the paydown, both in mortgage interest avoided and years sliced off the schedule. Much more so than slowly paying $1,000 per month.

Again, it takes major budgeting skills and discipline to do this, but the strategy is simple in its execution.

@Roy N.

You're absolutely right.  I did the math...


Loan Details

200K
30 years
4% interest
Starts on March 1, 2019


With Nothing Extra

Last Payment = (2/1/2049)  360 months
Total Interest = $143,739.02


Strategy A:  Extra Principal = 1K per Month
Last Payment = (8/1/2029)  125 months
Total Interest = $45,007.70


Strategy B:  Extra Principal = 12K per Year
Last Payment = (3/1/2029)  120 months
Total Interest = $42,213.1


The idea of using a simple line of credit (HELOC, credit card, or whatever) to make large payments on the the principal of your amortized loan in an effort to reduce the total interest that accumulates does work. However, its not significantly better than just making extra principal payments.

With both strategies illustrated above you are committing to making an extra 1K payment per month.  Strategy A pays that directly to the principal on the mortgage and strategy B pays it to the line of credit that was used to make an annual payment of equal value to the principal of the mortgage (to pay earlier).  Of course, there will be a fee for using the line of credit, which will vary depending on the terms, but will most likely put strategy B behind overall.

With that said, strategy B does have a benefit that strategy A does not.  Strategy B will likely improve your credit score and cause banks and other lenders to increase your credit limits.

I crunched the numbers using this calculator (no affiliation)... http://mortgage-x.com/calculators/extra_payment_ca..

Originally posted by @Gary Floring :

Brent,

If a mortgage holder was "house rich but cash poor" they might have some usable equity in their property but nothing in their savings account (sad, but there ARE people who live paycheck to paycheck!).  

In that case, wouldn't they be using "someone else's money" if they took a $10,000 from a line of credit to place onto the mortgage? Yes, they would have to pay it back over the next 12 months from their ongoing income at the rate of almost $1,000 per month, but they would have already avoided tens of thousands of dollars in interest and years of time from their mortgage, correct? 

Then they simply lather, rinse, repeat, and the continue to use another $10,000 from a line of credit each year until its paid off, never having extra funds in their savings account.

Let me know where you agree or disagree with the points above.... Thanks

Using David's example of $200k borrowed at 4% over 30 years, the total interest payable is a little over 70% on top of the original principal. Which means that you have not "avoided tens of thousands of dollars in interest and years of time from their mortgage" by merely paying back $10k in principal during the first year (using borrowed money). You'd be saving around $7k, if you stick to your budget of paying back the full 10k within a year! Meanwhile, the original amortized payments will also be due each month, right up until all the principal is paid off.

Summarizing David's summary: If you pay off around $100k in principal ahead of time (with your money, not because of the HELOC), you could save around $100k in interest.

[But, not in today's opportunity value. You're still waiting ten years].

The main counter-argument used here on BP is: How much more could be achieved with that extra $100k than merely paying off a low-interest-rate mortgage early? Cheers...

@David Kirkland

Thanks to Commutative, Associative and Distributive properties of mathematics (multiplication) ;-)

In your Scenario B, do not forget to take the interest payed on the LoC into consideration.

For an extra giggle, look at increasing your mortgage payment frequency from monthly to bi-weekly (26 payments per year) and apply half ($500) or the extra $1000.00/month principle pre-payment to each bi-weekly payment.

Before I get sucked into this never-ending debate that this has become (17 pages and going - holy crap!), let me state a few things I clearly understand:

1) The reason interest on a loan is saved is because the principle is paid down, not because of some shell game. 4.5% interest in a mortgage = 4.5% interest in a HELOC.

2) It is always beneficial (to some extent) to use a HELOC if the interest rate on the HELOC is lower than the mortgage.

3) It is not beneficial to use this method if you spend more than you make every month, if so try Dave Ramsey

4) Everyone besides me on BP easily earns a 25%+ ROI on new investments that they buy every day without breaking a sweat, even in today's overheated market, so it's dumb to even think about paying down a 4% mortgage.

With that out of the way, at this point I believe in the value of the HELOC. I haven't looked at all of the spreadsheets, but has daily balance been figured into the calculations? If so, what assumptions about cashflow are being made to the HELOC's usefulness?

For example, suppose someone uses a HELOC (5% interest rate) to pay $5k down on a $200k mortgage (4.5% interest rate). He receives $5k of rents on the 1st of the month, pays $4k of mortgages on the 15th, and uses the HELOC as his checking account. Alternatively, he could simply pay down the mortgage by $1k on the 15th. Isn't the $5k that's paying down the average daily balance (for 50% of the month) of the HELOC saving him interest vs paying down the mortgage by $1k once a month? If so, wouldn't you rinse and repeat every month?

I apologize if this is convoluted, I freely admit that I don't have a great understanding of average daily balances and my example is hard to understand, I wanted round numbers.  I also confined it to the realm of real estate, but the principle would hold true for personal finances.  It just seems to me that cash flows and average daily balance have been neglected in this discussion.

Originally posted by @Gary Floring :

In that case, wouldn't they be using "someone else's money" if they took a $10,000 from a line of credit to place onto the mortgage? Yes, they would have to pay it back over the next 12 months from their ongoing income at the rate of almost $1,000 per month, but they would have already avoided tens of thousands of dollars in interest and years of time from their mortgage, correct? 

This is incredible. As @Roy N. pointed out, the distributive property of mathematics tells us:

200,000 * .04 = (190,000 + 10,000) * .04

If you have a 200k mortgage at 4%, or a 190k mortgage at 4% and a 10k HELOC at 4%, you're paying EXACTLY the same amount of interest.

There's really nothing else to it. The savings come from paying your mortgage __OR__ HELOC early.

(200,000 - 10,000) * .04 = [(190,000 + 10,000) * .04] - (10,000 * .04)

Same thing. This is 6th grade math.

Originally posted by @Brannan Beasley :

Before I get sucked into this never-ending debate that this has become (17 pages and going - holy crap!), let me state a few things I clearly understand:

1) The reason interest on a loan is saved is because the principle is paid down, not because of some shell game. 4.5% interest in a mortgage = 4.5% interest in a HELOC.

2) It is always beneficial (to some extent) to use a HELOC if the interest rate on the HELOC is lower than the mortgage.

3) It is not beneficial to use this method if you spend more than you make every month, if so try Dave Ramsey

4) Everyone besides me on BP easily earns a 25%+ ROI on new investments that they buy every day without breaking a sweat, even in today's overheated market, so it's dumb to even think about paying down a 4% mortgage.

With that out of the way, at this point I believe in the value of the HELOC. I haven't looked at all of the spreadsheets, but has daily balance been figured into the calculations? If so, what assumptions about cashflow are being made to the HELOC's usefulness?

For example, suppose someone uses a HELOC (5% interest rate) to pay $5k down on a $200k mortgage (4.5% interest rate). He receives $5k of rents on the 1st of the month, pays $4k of mortgages on the 15th, and uses the HELOC as his checking account. Alternatively, he could simply pay down the mortgage by $1k on the 15th. Isn't the $5k that's paying down the average daily balance (for 50% of the month) of the HELOC saving him interest vs paying down the mortgage by $1k once a month? If so, wouldn't you rinse and repeat every month?

I apologize if this is convoluted, I freely admit that I don't have a great understanding of average daily balances and my example is hard to understand, I wanted round numbers.  I also confined it to the realm of real estate, but the principle would hold true for personal finances.  It just seems to me that cash flows and average daily balance have been neglected in this discussion.

Brennan, you're thinking about this correctly. The only part of this that "works" is the extent to which you can game the HELOC daily average balance. So, if you can dump 5k onto the HELOC early in the month, and pull that out progressively over the course of the month, you're saving 2,500 * (.04 / 12) = $8 per month (2,500 would be the average daily balance if you pulled the 5k out evenly over the month.)

We did dozens of hypotheticals, and even the more extreme ones topped out at $10 per month. It's really peanuts. This is the only way you can use a HELOC to save money on your mortgage.

The rest of this "system" is 100% hocus pocus foolishness.

@Brannan Beasley  Alternatively to @Chris May , rather than try to make assumptions and then figure the effect from the difference in average daily balance, I figured out what the difference in average daily balance would need to be to get to the same end result when working with just a modest 0.5% higher rate LOC. It turns out that the average daily balance needs to be lower by more than the total value of the LOC. Which means not only is it not working to your advantage, but it's actively working to your disadvantage...As seen here:

@Gary Floring  Lets say you took out a $100k mortgage @5%, with a monthly payment of 536.82. You pay down $5k on it with a LOC@5.5%, using the 'velocity'/HELOC method, and in order to pay that LOC back within 1 year you'll have an additional monthly payment of 429.18. That means you're actually paying 966.00 per month in total. Since you can afford to pay 966.00 per month, and we're talking about 'velocity' here, let's maximize this by continuing to do so every year until payoff. At this rate the mortgage itself will be paid off in Jan 2030 with 33,549.03 interest having been paid. However that last payment was a 1,771.69 LOC lump, so paying off the last of the LOC at 966.00 per month takes an extra 2 months and costs 11.85 in interest. Additionally, you paid 150.21 in interest on each previous $5k LOC draw, totaling up to 1,652.31 over the 11 full years. Add these all together and the payoff took 134 months and at a cost of 35,201.31 in total interest paid on all debts.

Lets also say I took out a $100k mortgage @5%, with a monthly payment of 536.82, but I simply pay that same additional 429.18 on it per month. My mortgage will be paid off in May 2029 (124 months) with 31,136.78 in total interest paid. I will have paid off all debts 10 months sooner and at a savings of 4,064.56 over your method.

Now admittedly, I have not (yet) accounted for the lower average daily balance on your LOC...So let's look at that. Thanks to the modest 0.5% higher interest rate on your LOC, in order to keep up with my conventional over-payment method you will need a savings in interest of 32.78 per month on said LOC due to the reduced average daily balance. In order to achieve that savings from the LOC interest, you would need to maintain an average daily balance 7,151.72 lower than me...And if being equally diligent on both methods, it is not possible for the average daily balance savings from the LOC to be greater than the total value of the LOC itself.

In other words, while yes this accelerates your payback vs doing nothing, any higher interest rate on the LOC more than offsets the average daily balance savings. So despite the hype, the savings actually accumulate more slowly in the real world than other more conventional accelerated payment methods.

@Justin H. Thanks for mathing it up, I liked your algebraic approach to determining how much a HELOC would have to benefit to equal out. Thanks for taking the time to run through that, it was very thorough. Was your additional monthly payment to the HELOC of $429.18 an average of the year? I would think it would deteriorate every month as the principal was paid off. I'm not sure how sensitive the analysis was to that, but it appears to me that that payment is the main factor. I'm impressed with your ability to figure all that out, do you have a good spreadsheet of this? I've looked at a few old ones, but none were super user friendly/incorporated interest from the HELOC properly :(

Despite what the math says, this is so seductive. It's so tempting to look at the amortization schedules and want to knock off a huge chunk of time and interest by using the HELOC. My own basic analysis showed that the main effect was the principal reduction using personal income, the question was always which was a better way to do it. Thanks, @Chris May and Justin for giving me more to think about.

@Brannan Beasley The $429.18 is simply the principle and interest required to pay down any $5k debt @ 5.5% in 12 months.

If you take the time to understand in detail how each 'system' actually works, how to maximize using each, and approach each with equal financial discipline, then the easy and honest answer is to use which ever one(s) has the lowest interest rate(s).  Just as I showed above, when done in equally aggressive manners, the interest rate is the far and away the dominant factor. IF the HELOC had an equal or lower interest rate than the mortgage, then that method would have won out over the traditional mortgage over-payments. The problem is that few people (outside of Hawaii, apparently) seem to actually have access to such lower-than-mortgage rate HELOC's.

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