Use HELOC to paydown mortgage fast

415 Replies

Originally posted by @Eric Jones :

@David Dachtera ,

The proof that I provided with the two scenarios really settles this whole debate. I suggest carefully reviewing that particular example and understand the math I did. 

If you claim that my math is wrong, go ahead and point out where. But I assure you it's correct. 

Lastly, I don't need to hear the explanation provided in the video by spending an hour and a half listening. Like I've said, I learned about this technique a while ago, after listening to similar videos, and I made up my mind to determine if it was legitimate. At one point, I too was convinced it was some magical payoff strategy that counteracted the amortization, but I wasn't accounting for the fact that I now have principal and interest on a HELOC to account for as well. You can't look at the mortgage in isolation, you have to analyze the starting and ending values of the mortgage, HELOC, as well as total interest and payments made on both. Only when you do this will it make sense. If someone told you to spend an hour and a half watching a video where they are trying to prove that 2 + 2 = 5, I doubt you'd waste your time with it. I provided a proof - please explain how the math in that proof is wrong.

I've been reading this conversation with fascination. I remember an exercise in my financial management class in college that was very similar to what's being discussed here. 

The takeaway was that you're benefiting from prepayment (paying at the beginning of the period instead of the end). It has (almost) nothing to do with the interest calculation methodology. Simply throwing some cash at the mortgage on day one would have the same effect.

It's also possible that I'm missing some nuance in the point being debated between Eric and David.

@David Dachtera

I did the amortization spreadsheet exercise, and completely agree that by doing that you save lots in interest and payments compared to the original amortization schedule.   

But in reality those payment of principal and interest to the HELOC could rather be put to extra principal payment to the mortgage, and that is what many of the others are arguing.

In short:

Compared to the original amortization it saves a lot in interest and payments.

Compared to taking the HELOC payments and instead making extra principal payments - there is marginal savings that comes from the timing of interest.

I personally think that the right comparison is against the later example, since the cash flows are similar in each period.

@David Dachtera -

Just did the amortization exercise you described. You're correct that applying 4 extra payments of $3000 with the HELOC will rapidly speed up the payoff. But that's assuming that you're making the payment with cash, not interest-bearing debt. When you pay down the loan $3,000 while increasing your HELOC balance $3,000, you're actually prepaying in a way. Think about it - you're still making the minimum payment on the loan for $632.41, but you're also paying $7.50 in interest on the HELOC ($3,000 balance * 3%/12). So what has happened is you're gaining $7.50 in equity for each $632.41 payment as a result of the HELOC payoff of $3k.

150K Loan  - for the first payment of 632.41, 375 goes to interest and 257.41 goes to principle.

147K Loan - for the first payment of 632.41, 367.50 goes to interest and 264.91 goes to principle. But then you also have a 3K HELOC balance which accrues monthly interest of 7.50. So your total interest paid on the first payment is 367.50 + 7.50 = 375.

So in the 147K scenario, youre saving 7.50 in interest on the loan, but paying 7.50 in interest on the HELOC. It's a wash, since they both have the same interest rate.

One last comment to serve as a sanity check: the claim being made is that you can pay down your 30 year mortgage in 8 to 10 years, simply by shuffling the debt around, with no net increase in your monthly payment. This is impossible for the following reason:

For a second, assume the 150K loan was at 0% interest, so everything you pay goes to principle. In that scenario, making your monthly payment of 632.41, you'd payoff the loan in (150,000 / 632.41 ) = 237 months. So... if a 0 APR loan would take 237 months to payoff, how could a 3% interest bearing loan take 96 - 120 months to payoff? That's impossible! I work as a financial analyst and it's good to do big picture sanity checks like this when analyzing different scenarios.

@Gregory Dunton ,

I redid the amortization exercise as you suggested, and the effect is similar. I added $250 ($3,000 / 12) to the additional payment column starting at the 13th payment. The balance went to zero at the 228th payment. I also completed the exercise of making a $3000 additional payment every ten payments. The balance went to zero in 217 payments (not really what I expected, but I think I understand why).

So, @Eric Jones , it is ENTIRELY possible to pay the whole $150K off in 8 to 10 years by adjusting the size of the "chunks" you pay toward it and possibly the frequency as well, depending on your overall repayment goals and the resources you have available.

Thank you, gents! I've learned a lot going through this exercise with you.

Originally posted by @David Dachtera :

@Eric Jones ,

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

Unfortunately, this isn't true. There's no functional difference in interest calculation between a revolving credit line and an amortizing loan. The only difference is in way you pay it off, but in the end that has no impact on the amount of interest paid.

I finally got around to watching that video and my takeaway is that it's mostly just smoke and mirrors. The crux of why the method in the video works is 1) you're paying extra towards your loan balance every month (the HELOC is a wholly unnecessary step) and 2) it assumes you're using your entire paycheck to pay off the loan every month and then spending out of the HELOC account. That could potentially have an impact on the interest calculation as you start the month with a low balance and work it up during the month as you pay for things, rather than starting with a high balance. So really, the whole concept boils down to point #2.

To drive home the point that there's no real difference in interest calculation between a revolving credit line and a fixed payment (amortizing) loan, imagine buying a car on one or the other. Whether you pay for a car with a credit card or a traditional amortizing loan, the length of time to payoff (and total interest paid) is exactly the same for either as long as the interest rate is the same and you make the same payments every month.

Anyway, good discussion. This was a fun exercise.

@Chris May

"There's no functional difference in interest calculation between a revolving credit line and an amortizing loan. The only difference is in way you pay it off, but in the end that has no impact on the amount of interest paid."

Exactly. You hit the nail on the head. The interest paid is purely a function of the balance, interest rate, and compounding period. Amortization affects how the PAYMENT is calculated, not the interest. Like I've said, amortization isn't some magical phenomenon with a magical solution. The way to fight the high interest caused by an amortized loan is to prepay and get the best rate possible. This happens to be exactly the same way to avoid excessive interest on a HELOC.

Good discussion guys.

@Eric Jones and @Chris May ,

I think you both need to do some more research!

If you think that's true, then perhaps you can explain why the interest and principal portions of the payment on an amortized loan decrease and increase respectively in INVERSE proportion over the life of the loan while they both decrease in DIRECT proportion in a revolving (non-amortized) line if no further portion of the credit line is used.

Sorry, guys, it's just not true, and neither wishing nor arguing will make it so.

From a quick search, I found this page explaining the formula to amortize a loan. Very much like the formula the instructor gave the class in a COBOL programming exercise when I was in computer school. It would actually be much easier to code in many other programming languages.

From my worksheet where I calculated the interest paid each time the HELOC is paid to zero before putting a "chunk" toward the 1st mortgage:

  • (outstanding balance) x (APR / 12) = this month's interest payment

Another way to express that (for credit cards, for example) might be:

  • (average daily balance) x (daily periodic rate x number of days in billing period)

NOW do you see / understand the difference?

(Just discovered I actually did it wrong earlier. The interest paid over the ten months to repay the $3,000 HELOC "chunk" is only $51.56 for an interest-only line, not $618 or so. My mistake.)

Originally posted by @David Dachtera :

@Eric Jones and @Chris May,

I think you both need to do some more research!

If you think that's true, then perhaps you can explain why the interest and principal portions of the payment on an amortized loan decrease and increase respectively in INVERSE proportion over the life of the loan while they both decrease in DIRECT proportion in a revolving (non-amortized) line if no further portion of the credit line is used.

Sorry, guys, it's just not true, and neither wishing nor arguing will make it so.

From a quick search, I found this page explaining the formula to amortize a loan. Very much like the formula the instructor gave the class in a COBOL programming exercise when I was in computer school. It would actually be much easier to code in many other programming languages.

From my worksheet where I calculated the interest paid each time the HELOC is paid to zero before putting a "chunk" toward the 1st mortgage:

  • (outstanding balance) x (APR / 12) = this month's interest payment

Another way to express that (for credit cards, for example) might be:

  • (average daily balance) x (daily periodic rate x number of days in billing period)

NOW do you see / understand the difference?

(Just discovered I actually did it wrong earlier. The interest paid over the ten months to repay the $3,000 HELOC "chunk" is only $51.56 for an interest-only line, not $618 or so. My mistake.)

I really don't know how to say it any other way. For my "real" job, I'm an accounting policy manager at a Fortune 50 company and I deal with amortization formulas on an almost daily basis. Amortization is not an interest calculation methodology, but rather a payment calculation methodology. 

The interest paid in each period of an amortizing loan is a function of the remaining loan balance, nothing else. As the principal balance is drawn down, the interest due is less. The same is true of a HELOC. If the HELOC balance is 100,000 and pay 1,000 each month, most of that payment will be going towards the interest accrued. However, if my balance is 10,000 and I pay 1,000, the interest accrued is lower so my 1,000 payment will have a greater impact on drawing down the principal than with the 100,000 balance.

@Chris May ,

So, it seems we agree then. I'm sure you use formulas similar to the one shown on the linked web page.

Mortgage acceleration is about using lower (or no) interest sources to pay down big chunks of the mortgage banalce. This eliminates payments 

The point is that the HELOC (or other credit line) itself does not figure into the mortgage acceleration scenario at all - it could just as easily be a revolving personal / unsecured credit line. That where it seems both you and Eric keep knocking yourselves off the track.

Repaying the "chunk" between applying chunks to the 1st mortgage is the ONLY time the credit line enters into consideration.

You could just as easily use an additional source of income to build up "chunks" and not use a credit line at all and, as I demonstrated earlier (and you can do yourself with the Amortization Schedule Spreadsheet), still eliminate more payments and interest than simply paying additional principle every month.

You CAN accelerate repayment of a credit line, yes. But, that's not under discussion here.

@David Dachtera

David, like Chris I also work in finance - I'm a financial analyst and set rates for a utility company and do financial analysis for a private equity firm. I also have masters degrees in both engineering and finance. Chris is 100% right in what he's said. The confusion seems to be with your understanding of the payment on an amortized loan. You're thinking of the payment being divided into two pieces, but this is technically an incorrect way to think about it. The correct way to view your payment on an amortized loan is to first take your loan balance and then multiply it by the interest rate/number of compounding periods. This will give you the interest that accrues over the month. Then take the loan balance + the interest you just calculated - the entire payment. The result is your ending balance after accounting for interest and the payment. The problem, I believe, is you're not subtracting the entire payment. You're dividing the payment up, which you shouldn't be. 

Can you do an exercise for me?

Say you have three debts: a 150K amortized loan, a 147K amortized loan, and a 3K HELOC. Assume all are at a 3% interest rate. After the first month, how much interest did you accrue on each?

Also, if you want to take it a step further, what is the ending balance on each, assuming you make the minimum payment (and an interest only payment on the HELOC). Note: the monthly payment on the 150K loan and 147K loan should both be $632.41, since both originated as 150K loans - the difference is you paid down one with $3K from your HELOC...

Don't worry about future interest or payments on any of the debts - just focus on month 1. The net interest is the sum of the interest incurred in each individual month, so if we can demonstrate that you have no net savings in month 1, it follows that you'll never see a net savings in future months. 

Thanks for everyone's input. it's a great discussion.

I think "time" is a crucial element when you calculate interest. if you pay on the same day every month and make the same number of payments over 30 years given the interest rate is the same. Of course the total interest paid will be the same for both methods. However, if you are able to pay a chunk right now, rather than save the same amount six months later. It will create a big different. When paying down debt, time is not your friend.

interest is acquired daily. once you understand that concept it is easy to understand how this can work to your advantage, but there is a breaking point with rates. best of luck

@Joe Au - agreed, but only if your payment is a cash/non-debt payment. Making a debt payment using other debt (like a HELOC) perfectly offsets the gains, assuming the same interest rate. The reason for this is simple - you're just transferring debt. The interest rate determines how quickly interest accumulates on each dollar of debt, so it's proportional with size. It's a perfectly linear relationship. A 100K balance accrues interest 100X faster than a 1K balance. 

Hoping that David does the exercise I suggested. It will be very revealing...

What are the typical pre-payment and mortgage payment increase restrictions on a fixed rate residential mortgage in the U.S.A.?

Here in Canada, those taking a fixed-rate, fixed-term mortgage will typically be allowed 10 - 20% prepayment per year and an increase in payment size also of 10 - 20%. 

I never use fixed rate mortgages, but even if one does, taking out an amount on a HELoC at prime (2.7%) to prime + 0.5 (3.2%) {the rate spread on most HeLoCs here) to pre-pay a fixed-rate mortgage at 2.6% (5-year term) would be at best a wash (unless rates were moving).

What makes it work in the U.S.A.?  .... I'm suspecting it is an artefact of having a mortgage term which matches your amortization.

@Eric Jones I know that the larger benefits are from pre paying the note not the HELOC as checking. I used it. If you have a much larger income then debt then it works. The larger the income and more the bills the better it works. I also know personally that you do get small savings by leveraging daily balances. Having all my bills go on a credit card and paying them off last day in full. then collecting the bonus points on the card. I really do it just because I enjoy the bonus points. Saving for Hawaii next year in the spring. I am sure the exercise will reveal that you have very minuscule gains using the HELOC as checking. However you are not using a daily balance and that very's person to person. someone could leverage 20,000 in bills every month and keep it against there debt vs giving it to banks/retail/ or other fine establishments and paying cash. As your small numbers would suggest the savings if any is very small. However if you run larger numbers and factor in daily balance and the fact that they get to hold onto all of their income and not pay any of there bills until the last day can make a difference. For the average JOE it is chump change. For warren buffet its 1,000's per day. The real exercise is using this HELOC the right way and that's not against your primary home and using it to purchase cash flowing real estate decreasing your daily balance owed on the HELOC and then repeating the buying when savings is saved and HELOC is at or approaching zero. If you look at it that way you will see why the book is right by not having a checking and using the HELOC for the daily balance leverage buy down however idiotic by telling folks to get rid of their savings. It makes sense if you are buying real estate with it to use it as a checking as otherwise your money just sits there not doing anything for you. why not leverage all your checking for the entire month against your HELOC buying down daily interest? I'm on the same page as you and feel as there are far better/safer ways to pay off your house and the HELOC should be used for both acquiring real estate and a checking account to fully leverage your monthly balance paying off the debt as fast as possible and repeating. If you get 60$ a month by having your money sit in the HELOC vs checking why not. Plus a free vacation to Hawaii every 3 years in bonus points is a huge bonus. Paying off my incredible low rate on my primary and taking away the tax advantage would not be in my best interest.

@Eric Jones ,

Sorry, Eric, you're still off the tracks. Study the amortization schedule. Plug in the numbers you propose. It will show you the answers.

For the interest-only HELOC calculations, build a spreadsheet like this:

A1: the beginning balance

B1: the annual interest rate

C1: =A1*(B1/12)

D1: The additional payment amount (I used 300: $3000 / 10)

E1: = C1 + D1

F1: = A1 - D1

A2: =F1

B2 thru F2: copy from B1 - F1

Copy B2 thru F2 to A10 thru F10

C11: =SUM(C1:C10)

Now, before you come back and try to explain why things work they way YOU think they do and not as per the spreadsheets, be prepared to explain what the spreadsheets are doing wrong FIRST. THEN, explain how to build spreadsheets that work the way YOU think they should.

We'll see where we go from there.

Doesn't matter how long you've been doing what you're doing the way you've been doing it. If it doesn't match the spreadsheet numbers, you may need to rethink how you're doing it ... or how you're explaining it. Something is wrong somewhere.

Account Closed,

It depends on your financial goals.

If accelerating your 1st mortgage doesn't suit your financial needs, don't do it.

It's that simple.

Chris and Eric have been throwing the HELOC in where it doesn't belong as a kind of red herring. You're not accelerating the HELOC, you're using the non-amortized HELOC as an "accumulator" to accelerate the amortized 1st mortgage. Period - end of statement.

@David Dachtera - doing it the way you described. This is incorrect, because Column E ("pmt (p + i)") is not correctly calculated. 

So here's the results from YOUR 10-month table:

PV r int princ pmt pmt (p+i) fv
$ 150,000.00 3% $ 375.00 $ 300.00 $ 675.00 $ 149,700.00
$ 149,700.00 3% $ 374.25 $ 300.00 $ 674.25 $ 149,400.00
$ 149,400.00 3% $ 373.50 $ 300.00 $ 673.50 $ 149,100.00
$ 149,100.00 3% $ 372.75 $ 300.00 $ 672.75 $ 148,800.00
$ 148,800.00 3% $ 372.00 $ 300.00 $ 672.00 $ 148,500.00
$ 148,500.00 3% $ 371.25 $ 300.00 $ 671.25 $ 148,200.00
$ 148,200.00 3% $ 370.50 $ 300.00 $ 670.50 $ 147,900.00
$ 147,900.00 3% $ 369.75 $ 300.00 $ 669.75 $ 147,600.00
$ 147,600.00 3% $ 369.00 $ 300.00 $ 669.00 $ 147,300.00
$ 147,300.00 3% $ 368.25 $ 300.00 $ 668.25 $ 147,000.00
Total Interest:   $ 3,716.25      

Since the 150K loan is amortized, the correct formula to calculate your monthly payment is:

A1 = "3%" interest rate per year

A2 = "360" compounding periods

A3 = "$150,000" beginning loan balance

A4 = enter the following payment function for an amortized loan "=pmt(A1/12, A2, A3, 0, 0)" = should give you a monthly payment of $632.41

The correct 10-month table looks like this: (note that you're making the same payment of $632.41. As I suspected, you're splitting up the payment, which you shouldn't be. It should be fixed every month.

PV Int PMT FV
$ 150,000.00 $ 375.00 $ (632.41) $ 149,742.59
$ 149,742.59 $ 374.36 $ (632.41) $ 149,484.54
$ 149,484.54 $ 373.71 $ (632.41) $ 149,225.85
$ 149,225.85 $ 373.06 $ (632.41) $ 148,966.51
$ 148,966.51 $ 372.42 $ (632.41) $ 148,706.52
$ 148,706.52 $ 371.77 $ (632.41) $ 148,445.88
$ 148,445.88 $ 371.11 $ (632.41) $ 148,184.59
$ 148,184.59 $ 370.46 $ (632.41) $ 147,922.64
$ 147,922.64 $ 369.81 $ (632.41) $ 147,660.04
$ 147,660.04 $ 369.15 $ (632.41) $ 147,396.79
Total Interest  $ 3,720.85  

Make sense now? 

@Chris May  

As Chris and I have mentioned, amortization has nothing to do with how interest is calculated, it has to do with how the payment is calcuted. Basically, in the above example, $632.41 is the monthly payment at which a 150K loan will get paid off in 360 months @ a 3% interest. This is the correct way to understand amortized loans - it's about the payment, not interest. Interest is purely a function of balance, rate, and compounding periods.

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