HELOC repayment on adjustable interest rate?

4 Replies

I'm looking into taking out a HELOC for a future investment. I understand the HELOC fixed rate repayment (just like a mortgage). What I'm not sure I understand is the HELOC repayment process on a variable interest rate. To my understanding, a variable interest rate would only have an interest rate on the balance of the HELOC, and therefore would change throughout the loan, as I paid down the HELOC.

Example:

I borrow $80,000 on my HELOC at a 6% interest rate. I want to pay down $20,000 off the principal in the first year.

Year 1 - I pay it down to $60,000 principal.  I'm then paying 6% interest on $60,000, right?

Year 2 - Paying on $40k?

Year 3 - Paying on 20k?

In this example, my monthly payments would get lower and lower, instead of being the same throughout the life of the loan.  This of course has me thinking if I owe around $80k on a mortgage on a rental property , rather than paying 5.5% interest on a fixed 30 year term, what if I paid a variable interest rate on just the $80k.  I know I've seen some talk of this on other websites, and wasn't sure if it was a legitimate strategy, or if I was missing something.  Anyone who could provide more insight, I would appreciate it.  

@Ben Kirchner I think part of your confusion is you are mixing lines of credit with traditional mortgages. Their interest and payments are not calculated the same. Your HELOC is calculated more like a credit card's interest where you are charged a certain percentage of the balance, and you pay down as much of the principal you want to, as you want to, subject to defined minimums.

So in the example, wouldn't I be paying less and less interest every month/year , given the balance in continually decreasing?  So if I pay $1000 every single month, more is going into the principal in year 2, compared to year 1.  Thus saving me more on interest and overall cost?

@Ben Kirchner A HELOC is a line of credit, just like a credit card, so you only pay interest on the outstanding balance. The lower the balance, the lower the payment. Most HELOCs have an interest only period, and a repayment period.

I'm not sure I understand what you're asking in the second part of the question. Even if you have a fixed rate 30 year loan, you can pay it down more quickly by making additional principal payments. The loan can be paid back in less than 30 years. You're always going to be paying interest on the outstanding balance. Unlike a HELOC, your minimum monthly payment will remain consistent. As your loan gets paid down, a higher portion of your payment goes toward principal. If you test out a loan calculator and look at the amortization schedule, you will see that the principal portion increases as the interest portion decreases, but your payment remains the same.

Originally posted by @Ben Kirchner :

So in the example, wouldn't I be paying less and less interest every month/year , given the balance in continually decreasing?  So if I pay $1000 every single month, more is going into the principal in year 2, compared to year 1.  Thus saving me more on interest and overall cost?

If you're still following this - the HELOC and mortgage calculate the interest paid based on the balance of the loan. The only thing that muddies things from your view is that HELOC only charges you for the interest calculated and you decide how much extra to pay. The mortgage forces you to pay the same amount every month whether you owe $80K or $800K and pays the interest and whatever is left to principal. Another way to look at it is if you paid the same amount from your mortgage to a HELOC with the same balance and same APR, the result would be the same since the interest owed each month along the way would be same.