HELOC payoff strategy
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HELOC payoff strategy
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Investor · Flower Mound, TX · Member since 2017 · 182 posts · 198 votes
8yI have a secret strategy to pay your mortgage off faster. You make bigger payments and/or more frequent payments than the amortization schedule requires. Now the bad news...I have a business method patent on this so you owe me a royalty every time you do it. If you don’t pay, I sue.
329 Replies
- Investor · Greenville, SC · Member since 2016 · 5k+ posts · 13k+ votes8y
Originally posted by @Brian Cardwell:
Originally posted by @Mike Dymski:
Originally posted by @Brian Cardwell:
Here is a basic break down of how this works. The interest rate is pretty much irrelevant.Basic facts :
Primary mortgage. Equals 200k
Salary equals 5k.
Total monthly expenses equals 3k
HELOC equals 20k in second position
So lets start this off.
First let's pull 10k out of the HELOC and put it on the principle of the 1st mortgage.
First mortgage = 190k
Heloc= 10k balance
Month 1
Then let's put your entire paycheck in the HELOC acct. This accomplishes paying the minimum payment on the HELOC.
HELOC= 5k balance
Now let's pay your expenses from your HELOC.
HELOC = 8k balance 5k(balance)+3k(expenses)
Month 1 balance
Primary mortgage 190k owed
HELOC 8k owed
Total debt 198k owed
Month 2
Put the entire paycheck in the HELOC
HELOC balance 3k owed (8k-5k)
Pay expenses of 3k
Mortgage Balance 190k
HELOC balance of 6k owed (3k+3k)
Total debt is 196k
Month 3
Pay expenses 3k
HELOC =9k
Put entire check in the HELOC
HELOC = 4k
Mortgage Balance owed 190k
HELOC = 4k
Total owed 194k
Rinse and repeat......
In month 5 your heloc balance owed will be 0.
Month 6
So in month 6 you put 10k from your heloc on the principle of your primary mortgage.
Primary mortgage Balance 180k.
HELOC balance is 10k
Total owed is 190k
Put your entire paycheck in the HELOC
HELOC balance. 5k
pay your expenses 3k
HELOC balance is 8k
Primary mortgage Balance is 180k
Total debt 188k
Month 7
Put entire paycheck in the HELOC 5k
HELOC = 3k
Pay your expenses 3k
HELOC balance is 6k
Mortgage Balance is 180
Total debt is 186k
At the end of one year your principle balance will be 180k . Not bad for living the same lifestyle and still have access to some cash.
Rinse and repeat until your debt is gone
It really is that simple.
The extra open credit (10k) on the HELOC above the 10k in this case is used as an emergency fund.
Brian, your example above is good. Is below an accurate image of it?
You are a smart guy and hard worker. You have purchased a home and investment properties and have aggressively paid down debt on both. You are way ahead of 95% of other people in the country. I respect you and BP and that's why I continue to reply (at 4 am).
Yes that looks to be correct.
Take the $2k savings each month and apply it to the 1st mortgage instead (see below). Is that image correct? If so, it illustrates that the mortgage acceleration is due to saving $2k each month and applying it to the 1st mortgage and it's not due to the use of the HELOC.
I also respect that many would like maintain access to their "savings" (i.e. the equity in the property created by accelerated principal reduction). That can be done with a HELOC...but the HELOC is not required to accelerate the 1st mortgage. That's the heart of the discussion. As you said, the program works...and accelerated payment of principal takes years off the mortgage.
- 8yBrian CardwellPro MemberInvestor · Odenton, MD · Member since 2017 · 204 posts · 144 votes
Originally posted by @Mike Dymski:
Let's clear up two items that have nothing to do with mortgage acceleration programs.
- Amortizing loans and HELOCs DO NOT not use compound interest
- Amortizing loans and HELOCs use the EXACT same simple interest calculation
$100,000 principal balance x 5% rate / 365 days = $13.6986 interest accrues each day for each type of loan until the principal is reduced.
These are the types of distractions that are used to promote these programs and they make it impossible to help members on this thread address what matters. Please squash them.
Mike isnt the interest on a mortgage calculated monthly?
- Investor · Midlothian, VA · Member since 2015 · 980 posts · 823 votes8y
@Kaydn Jensen, this could work in theory because you are transferring whatever your mortgage interest rate is at to 0%. It assumes that you can pay off the credit card in the time frame of the 0% promo, though. It also ignores the fact that you typically cannot take a cash advance for the full amount of your CC limit and usually have to pay a transaction fee on cash advances. I have seen 3% regularly for the transaction fee, which is roughly what my mortgage is at to begin with so the savings would not be that great. Additionally, this would obviously impact your credit score to some degree for new credit inquiries, maxing a particular revolving line of credit, and possibly your overall outstanding balance to available credit ratio. Personally, I'd be surprised if the juice was worth the squeeze in the end.
- Investor · Greenville, SC · Member since 2016 · 5k+ posts · 13k+ votes8y
Originally posted by @Brian Cardwell:
Mike isnt the interest on a mortgage calculated monthly?
No. The daily interest accrual changes on the date that a payment is made.
An amortization schedule is run at the origination of the loan and it assumes that all loan payments are made on the payment due date. This "perfect pay" amortization schedule is used to calculate the monthly payment but the application of each payment going forward to principal and interest is based on the actual dates that payments are made, not the original amortization schedule.
- 8yBrian CardwellPro MemberInvestor · Odenton, MD · Member since 2017 · 204 posts · 144 votes
Originally posted by @Mike Dymski:
Originally posted by @Brian Cardwell:
Originally posted by @Mike Dymski:
Originally posted by @Brian Cardwell:
Here is a basic break down of how this works. The interest rate is pretty much irrelevant.Basic facts :
Primary mortgage. Equals 200k
Salary equals 5k.
Total monthly expenses equals 3k
HELOC equals 20k in second position
So lets start this off.
First let's pull 10k out of the HELOC and put it on the principle of the 1st mortgage.
First mortgage = 190k
Heloc= 10k balance
Month 1
Then let's put your entire paycheck in the HELOC acct. This accomplishes paying the minimum payment on the HELOC.
HELOC= 5k balance
Now let's pay your expenses from your HELOC.
HELOC = 8k balance 5k(balance)+3k(expenses)
Month 1 balance
Primary mortgage 190k owed
HELOC 8k owed
Total debt 198k owed
Month 2
Put the entire paycheck in the HELOC
HELOC balance 3k owed (8k-5k)
Pay expenses of 3k
Mortgage Balance 190k
HELOC balance of 6k owed (3k+3k)
Total debt is 196k
Month 3
Pay expenses 3k
HELOC =9k
Put entire check in the HELOC
HELOC = 4k
Mortgage Balance owed 190k
HELOC = 4k
Total owed 194k
Rinse and repeat......
In month 5 your heloc balance owed will be 0.
Month 6
So in month 6 you put 10k from your heloc on the principle of your primary mortgage.
Primary mortgage Balance 180k.
HELOC balance is 10k
Total owed is 190k
Put your entire paycheck in the HELOC
HELOC balance. 5k
pay your expenses 3k
HELOC balance is 8k
Primary mortgage Balance is 180k
Total debt 188k
Month 7
Put entire paycheck in the HELOC 5k
HELOC = 3k
Pay your expenses 3k
HELOC balance is 6k
Mortgage Balance is 180
Total debt is 186k
At the end of one year your principle balance will be 180k . Not bad for living the same lifestyle and still have access to some cash.
Rinse and repeat until your debt is gone
It really is that simple.
The extra open credit (10k) on the HELOC above the 10k in this case is used as an emergency fund.
Brian, your example above is good. Is below an accurate image of it?
You are a smart guy and hard worker. You have purchased a home and investment properties and have aggressively paid down debt on both. You are way ahead of 95% of other people in the country. I respect you and BP and that's why I continue to reply (at 4 am).
Yes that looks to be correct.
Take the $2k savings each month and apply it to the 1st mortgage instead (see below). Is that image correct? If so, it illustrates that the mortgage acceleration is due to saving $2k each month and applying it to the 1st mortgage and it's not due to the use of the HELOC.
I also respect that many would like maintain access to their "savings" (i.e. the equity in the property created by accelerated principal reduction). That can be done with a HELOC...but the HELOC is not required to accelerate the 1st mortgage. That's the heart of the discussion. As you said, the program works...and accelerated payment of principal takes years off the mortgage.
I agree with you except...wait for it ....wait for it.... interest payment on this senario,@5% equals 833+826+817+809+793 = 4078for the first 5 payments
With early example using the heloc the interest payments for the first five Payments are 793+786+776+767+752=3874 on top of this more of your normal payment is going to the principle. As we drop lump sums on the principle our interest drops substantially. So to drop your principle by lump sums may have a better result.
You are correct that the HELOC is not necessary to achieve acceleration. But I would rather use the banks money so that I still have easy Access to my money.
For the record 10 % for the Heloc was used for simplicity of the math. The actual rate I used was prime - .50.
- 8yBrian CardwellPro MemberInvestor · Odenton, MD · Member since 2017 · 204 posts · 144 votes
Originally posted by @Mike Dymski:
Originally posted by @Brian Cardwell:
Mike isnt the interest on a mortgage calculated monthly?
No. The daily interest accrual changes on the date that a payment is made.
An amortization schedule is run at the origination of the loan and it assumes that all loan payments are made on the payment due date. This "perfect pay" amortization schedule is used to calculate the monthly payment but the application of each payment going forward to principal and interest is based on the actual dates that payments are made, not the original amortization schedule.
Ok fair enough
- Investor · Midlothian, VA · Member since 2015 · 980 posts · 823 votes8y
Yeah, this strategy makes no sense to me based on what was in the spreadsheet @Brian Cardwell provided. That assumes you will apply the HELOC payment to the principle of the 1st mortgage and so will be on the hook for the mortgage payment and paying down the HELOC at the same time. Of course you will pay off your mortgage faster if you put yourself in that situation. That's a big nut to crack every month, though, and could put you in a hurt locker if your financial situation changes. Better to just get a HELOC and make additional payments to mortgage as some have suggested.
I agree with @Scott Perry that for this to have any viability at all you would have to completely replace your 1st mortgage with a HELOC. Otherwise, you are indeed paying your mortgage down faster, but the equity you are freeing up is still trapped in the property. You would still have to refi or get another HELOC to free up the extra principle payments you are making to your mortgage.
The dangers of replacing your entire mortgage with a HELOC can not be understated, or even using a HELOC in the spreadsheet example above. I once paid off a $24k HELOC in 6 months in preparation for my wife going back to school. I wanted access to that money but didn't want to pay interest on it until I needed it. USAA froze the HELOC the month after I paid it off. USAA! What happens to this strategy if you can no longer draw on your HELOC. You are now trapped in a higher interest rate loan that can go up every month. Add to that the tax disadvantages and other concerns and this starts to become a very risky strategy of dubious benefit to begin with.
If you are extremely savvy I can see potential benefits to using this strategy but most of the champions don't appear to fully understand why or how it works, which makes it even more dangerous. They repeat the catch phrases off of YouTube videos ("It's all about he difference between simple and compound interest") that are extremely misleading as if they were fact and then willfully ignore the truth of how different types of loans and debt actually work. Most of the debate seems to me to be because the proponents don't fully understand why and how it works and so cannot properly defend it and the antagonists are focused on shooting holes in the proponents arguments (which is very easy to do) rather than explore if there is any actual merit to this strategy. Regardless, I think it is safe to say that this is not a good strategy for your average investor since no one has been able to succinctly outline the pros and cons of using it.
- 8yBrian CardwellPro MemberInvestor · Odenton, MD · Member since 2017 · 204 posts · 144 votes
@Edward B
I can't speak for others but I as a Champion (thanks btw) I did this 18years ago. There was little information on this at that point. It took me less than seven years to pay off my mortgage using this method. Could I have done it a different way? Sure probably but I accomplished my goal. This is just one way to do it. One needs to evaluate what their risk tolerance is and decided if this is for them. For me it is no different than deciding how to invest my money.
- Investor · Greenville, SC · Member since 2016 · 5k+ posts · 13k+ votes8y
Originally posted by @Brian Cardwell:
Originally posted by @Mike Dymski:
Originally posted by @Brian Cardwell:
Originally posted by @Mike Dymski:
Originally posted by @Brian Cardwell:
Here is a basic break down of how this works. The interest rate is pretty much irrelevant.Basic facts :
Primary mortgage. Equals 200k
Salary equals 5k.
Total monthly expenses equals 3k
HELOC equals 20k in second position
So lets start this off.
First let's pull 10k out of the HELOC and put it on the principle of the 1st mortgage.
First mortgage = 190k
Heloc= 10k balance
Month 1
Then let's put your entire paycheck in the HELOC acct. This accomplishes paying the minimum payment on the HELOC.
HELOC= 5k balance
Now let's pay your expenses from your HELOC.
HELOC = 8k balance 5k(balance)+3k(expenses)
Month 1 balance
Primary mortgage 190k owed
HELOC 8k owed
Total debt 198k owed
Month 2
Put the entire paycheck in the HELOC
HELOC balance 3k owed (8k-5k)
Pay expenses of 3k
Mortgage Balance 190k
HELOC balance of 6k owed (3k+3k)
Total debt is 196k
Month 3
Pay expenses 3k
HELOC =9k
Put entire check in the HELOC
HELOC = 4k
Mortgage Balance owed 190k
HELOC = 4k
Total owed 194k
Rinse and repeat......
In month 5 your heloc balance owed will be 0.
Month 6
So in month 6 you put 10k from your heloc on the principle of your primary mortgage.
Primary mortgage Balance 180k.
HELOC balance is 10k
Total owed is 190k
Put your entire paycheck in the HELOC
HELOC balance. 5k
pay your expenses 3k
HELOC balance is 8k
Primary mortgage Balance is 180k
Total debt 188k
Month 7
Put entire paycheck in the HELOC 5k
HELOC = 3k
Pay your expenses 3k
HELOC balance is 6k
Mortgage Balance is 180
Total debt is 186k
At the end of one year your principle balance will be 180k . Not bad for living the same lifestyle and still have access to some cash.
Rinse and repeat until your debt is gone
It really is that simple.
The extra open credit (10k) on the HELOC above the 10k in this case is used as an emergency fund.
Brian, your example above is good. Is below an accurate image of it?
You are a smart guy and hard worker. You have purchased a home and investment properties and have aggressively paid down debt on both. You are way ahead of 95% of other people in the country. I respect you and BP and that's why I continue to reply (at 4 am).
Yes that looks to be correct.
Take the $2k savings each month and apply it to the 1st mortgage instead (see below). Is that image correct? If so, it illustrates that the mortgage acceleration is due to saving $2k each month and applying it to the 1st mortgage and it's not due to the use of the HELOC.
I also respect that many would like maintain access to their "savings" (i.e. the equity in the property created by accelerated principal reduction). That can be done with a HELOC...but the HELOC is not required to accelerate the 1st mortgage. That's the heart of the discussion. As you said, the program works...and accelerated payment of principal takes years off the mortgage.
I agree with you except...wait for it ....wait for it.... interest payment on this senario,@5% equals 833+826+817+809+793 = 4078for the first 5 payments
With early example using the heloc the interest payments for the first five Payments are 793+786+776+767+752=3874 on top of this more of your normal payment is going to the principle. As we drop lump sums on the principle our interest drops substantially. So to drop your principle by lump sums may have a better result.
You are correct that the HELOC is not necessary to achieve acceleration. But I would rather use the banks money so that I still have easy Access to my money.
For the record 10 % for the Heloc was used for simplicity of the math. The actual rate I used was prime - .50.
Use line 16 to calculate the interest due...need to include both loans. The interest due is exactly the same in both scenarios.
- Rental Property Investor · Sioux Falls, SD · Member since 2015 · 9k+ posts · 18k+ votes8y
Originally posted by @Kyle N.:
It works! If you have $20k in reserve account making 0.04% in a savings account, you can apply all of that towards your Heloc and get it back out if you ever need it by simply writing a check. Try that with your mortgage. You have to cash out refi to get access to your equity.
Example: $100k balance
After applying your reserve account to your balance, you only pay SIMPLE interest on remaining $80k rather than amortized interest on $100kThis isn't anything special about a HELOC. All you are saying is instead of holding $20K reserves in a savings account, pay your mortgage down by $20K. Then in the future if you need money, use your line of credit, whether that be a HELOC, credit care or business line of credit, doesn't really matter. Cash in the bank is not the same as having a line of credit. The credit can be pulled at any time, which is what happened to may people after the crash in 2008.
On your second point, amortized isn't a type of interest, it is a way to level payments over a period of time. A mortgage pre-determines even payments so that principal+interest pays the loan off in a specific amount of time. On a HELOC usually you just have to pay the interest only and your principal payment is your choice. If you apply the same principal+interest payments to a mortgage and HELOC, they will pay off in the same amount of time. It is how much principal you are paying that matters most in either type of loan.
I recommend people maintain cash reserves. Access to credit is different than cash reserves. Investors should have both.
- Rental Property Investor · Sioux Falls, SD · Member since 2015 · 9k+ posts · 18k+ votes8y
Originally posted by @Edward B.:
Yeah, this strategy makes no sense to me based on what was in the spreadsheet @Brian Cardwell provided. That assumes you will apply the HELOC payment to the principle of the 1st mortgage and so will be on the hook for the mortgage payment and paying down the HELOC at the same time. Of course you will pay off your mortgage faster if you put yourself in that situation. That's a big nut to crack every month, though, and could put you in a hurt locker if your financial situation changes. Better to just get a HELOC and make additional payments to mortgage as some have suggested.
I agree with @Scott Perry that for this to have any viability at all you would have to completely replace your 1st mortgage with a HELOC. Otherwise, you are indeed paying your mortgage down faster, but the equity you are freeing up is still trapped in the property. You would still have to refi or get another HELOC to free up the extra principle payments you are making to your mortgage.
The dangers of replacing your entire mortgage with a HELOC can not be understated, or even using a HELOC in the spreadsheet example above. I once paid off a $24k HELOC in 6 months in preparation for my wife going back to school. I wanted access to that money but didn't want to pay interest on it until I needed it. USAA froze the HELOC the month after I paid it off. USAA! What happens to this strategy if you can no longer draw on your HELOC. You are now trapped in a higher interest rate loan that can go up every month. Add to that the tax disadvantages and other concerns and this starts to become a very risky strategy of dubious benefit to begin with.
If you are extremely savvy I can see potential benefits to using this strategy but most of the champions don't appear to fully understand why or how it works, which makes it even more dangerous. They repeat the catch phrases off of YouTube videos ("It's all about he difference between simple and compound interest") that are extremely misleading as if they were fact and then willfully ignore the truth of how different types of loans and debt actually work. Most of the debate seems to me to be because the proponents don't fully understand why and how it works and so cannot properly defend it and the antagonists are focused on shooting holes in the proponents arguments (which is very easy to do) rather than explore if there is any actual merit to this strategy. Regardless, I think it is safe to say that this is not a good strategy for your average investor since no one has been able to succinctly outline the pros and cons of using it.
This debate always runs into HELOC proponents saying, I paid my mortgage off early using this method so it works. That may be true, but that doesn't mean it is the best method. I could use credit cards to pay my mortgage off early, so does that mean I should? As you pointed out, when you transfer debt from a mortgage to a HELOC, you are now responsible for the minimum monthly payment and the HELOC interest payment. That is probably why the HELOC method works, because it forces people to pay more each month. I have paid mortgages off early, by simply making extra principal payments to my mortgage. I have the discipline to do this, so I don't need to be forced to save money. It works just as well, without transferring debt to another loan.
Bottom line is that to pay any loan off early, you need to make extra principal payments. No need to buy a book to explain some secret method. Just make extra principal payments each month and you will shave years off the loan.
- Las Vegas, NV · Member since 2017 · 89 posts · 52 votes8yOne situation in which I see this being valuable, if you have a low introductory rate in your heloc, AND that low rate can be paid off prior to its expiration is if you currently have PMI on your first and you are close to paying your loan down to where the PMI will go away. PMI pays nothing down, it's an extra cost because your 1st is over maybe 80%. My first home is an excellent example. It's fixed at 3.5% for 30 years. We've been paying an extra $135.00 each month bc I like the round $1000.00 payment and want to eliminate my PMI of $124.00/month. We are now close to paying off 20% and then my payment will reduce by $124/month. If I wanted to take a heloc at a low interest rate and use it to bump my 1st below the PMI threshold, then $0.00 are going to costs that aren't interest or principal. However, in my situation we're so close I don't need the heloc to do it, I can use savings. Some may analyze their situation & realize it makes sense for them.
- Las Vegas, NV · Member since 2017 · 89 posts · 52 votes8yI should mention that my PMI is there until I pay down 80% of the INITIAL purchase price, and it stands independent of 2nds or HELOCS. Also that HELOC can be taken based on Current home value. So if you've had a property for a few years paying it down, and you've been fortunate to have it appreciate, using HELOC to kill PMI would be a viable option. But again, exercise control, don't buy a boat.
- Rental Property Investor · Sioux Falls, SD · Member since 2015 · 9k+ posts · 18k+ votes8y
Originally posted by @Steve C.:
I should mention that my PMI is there until I pay down 80% of the INITIAL purchase price, and it stands independent of 2nds or HELOCS. Also that HELOC can be taken based on Current home value. So if you've had a property for a few years paying it down, and you've been fortunate to have it appreciate, using HELOC to kill PMI would be a viable option. But again, exercise control, don't buy a boat.
Using a HELOC to get rid of PMI would be a smart move, assuming the HELOC rate is reasonable. The problem is usually a HELOC requires equity in the property, which usually there isn't much equity if you have PMI. There could be equity if the property appreciated in value, but in that case you could also use an appraisal to get rid of PMI. Either way, finding a way to get rid of PMI should is usually a good idea.
- Construction Project Manager · Sycamore, IL · Member since 2015 · 91 posts · 109 votes8y
See: "EXAMPLE" at the END of this POST
I mis-spoke about the amortized interest, what I meant was that interest is front loaded on an amortized schedule with a mortgage, where the first payments are nearly all interest with a very small principal paydown. The HELOC strategy definitely is not for everyone, but if you want to aggressively pay down your balance and you have more income than expenses, in my opinion, it is the better option. If you are in the 20th year of a 30yr mortgage, I would keep the mortgage, but if you're closer to the front end of it, I chose to go the HELOC route on my personal residence.
I guess credit could be pulled at anytime, but if you are in good standing with the bank, it is less likely that would happen. According to my bank, nobody's credit has ever been frozen as long as they were in good standing, even through the 08 crisis. There are plenty of mortgage products out there that can be called as well, so in my mind, those are tradeoffs.
Each month (or day) that my HELOC gets the principal paid down, the lower my interest only payment is, so if I do fall on hard times, I can elect to make a much smaller interest only payment for a month or two until I get back on my feet, then I can aggressively pay down again. Yes you can aggressively pay down your mortgage as well, but your payment is fixed no matter what the principal balance is, and you will only shorten the life of the loan, never reduce the payment. So if you fall on hard times, your full payment is still due at the first of the month. Worse yet, if you need to get out of a jam and you don't have enough reserves, and you need to access some of your equity, you have to go back to the bank and ask for a cash out refi, with all the fees and costs along with it. And what are the odds of getting that refi if you are on hard times? Bankers are happy to give you an umbrella when the sun is shining!
If you need access to your equity with a HELOC, you ask yourself if it's ok to write a check... no need to get it blessed by the bank. OR if you would like to buy another property in an outside market, and you already have 10 mortgages, you can write a check out of your HELOC for full purchase price, paying cash for the property, like I just did. Now I've created more cashflow to throw back against my HELOC balance to pay it down even quicker for my next acquisition.
EXAMPLE:
So let's say that you have an "Acquisition Savings Account" with $50k in it, making essentially nothing in interest, and meanwhile, you have your newly purchased primary residence in a 30yr fixed mortgage of $100k at 3.75%. Your payment is $463.12. The first payment is $312.50 to interest and 150.62 to principal.
Now each month you add as much as you can to your acquisition account as well as obviously paying your mortgage. Lets say that you put $2k each month towards the acquisition account and in 25 months you have $100k to purchase your next property or whatever you want the money for. Meanwhile you paid $7,667.86 in interest on your primary residence.
If you had a first lien HELOC on your primary residence at 5%, and lets assume a rate increase of 0.75% each year. Now you could take that original $50k acquisition account and immediately put that towards your balance which will reduce your interest only payment down to $208.33. Now each month, you continue to put your $2k away, but now you put it into the HELOC. You will also put the original mortgage payment of $463.12 towards it as well. Now, you will have paid off that HELOC in 22 months paying $2,431 in interest.
Now you can write a check for up to $100k for anything you want like a cash flowing property. Yes, you will reset your HELOC balance, but now you should have an extra +/-$650 cashflow from your last purchase to dump into the HELOC. With your new payment of $3113 per month, you will have paid off that $100k in 35months starting at 6.5% interest, and again increasing at a rate of 0.75% per year.
This formula definitely isn't cut and dry, and is not for everyone. We all know people who are going to buy a boat as soon as they get enough equity, but for us disciplined RE investors, it's a tool that you should know and learn about and consider even if the rates are higher.
- Rental Property Investor · Sioux Falls, SD · Member since 2015 · 9k+ posts · 18k+ votes8y
Originally posted by @Kyle N.:
See: "EXAMPLE" at the END of this POST
I mis-spoke about the amortized interest, what I meant was that interest is front loaded on an amortized schedule with a mortgage, where the first payments are nearly all interest with a very small principal paydown. The HELOC strategy definitely is not for everyone, but if you want to aggressively pay down your balance and you have more income than expenses, in my opinion, it is the better option. If you are in the 20th year of a 30yr mortgage, I would keep the mortgage, but if you're closer to the front end of it, I chose to go the HELOC route on my personal residence.
I guess credit could be pulled at anytime, but if you are in good standing with the bank, it is less likely that would happen. According to my bank, nobody's credit has ever been frozen as long as they were in good standing, even through the 08 crisis. There are plenty of mortgage products out there that can be called as well, so in my mind, those are tradeoffs.
Each month (or day) that my HELOC gets the principal paid down, the lower my interest only payment is, so if I do fall on hard times, I can elect to make a much smaller interest only payment for a month or two until I get back on my feet, then I can aggressively pay down again. Yes you can aggressively pay down your mortgage as well, but your payment is fixed no matter what the principal balance is, and you will only shorten the life of the loan, never reduce the payment. So if you fall on hard times, your full payment is still due at the first of the month. Worse yet, if you need to get out of a jam and you don't have enough reserves, and you need to access some of your equity, you have to go back to the bank and ask for a cash out refi, with all the fees and costs along with it. And what are the odds of getting that refi if you are on hard times? Bankers are happy to give you an umbrella when the sun is shining!
If you need access to your equity with a HELOC, you ask yourself if it's ok to write a check... no need to get it blessed by the bank. OR if you would like to buy another property in an outside market, and you already have 10 mortgages, you can write a check out of your HELOC for full purchase price, paying cash for the property, like I just did. Now I've created more cashflow to throw back against my HELOC balance to pay it down even quicker for my next acquisition.
EXAMPLE:
So let's say that you have an "Acquisition Savings Account" with $50k in it, making essentially nothing in interest, and meanwhile, you have your newly purchased primary residence in a 30yr fixed mortgage of $100k at 3.75%. Your payment is $463.12. The first payment is $312.50 to interest and 150.62 to principal.
Now each month you add as much as you can to your acquisition account as well as obviously paying your mortgage. Lets say that you put $2k each month towards the acquisition account and in 25 months you have $100k to purchase your next property or whatever you want the money for. Meanwhile you paid $7,667.86 in interest on your primary residence.
If you had a first lien HELOC on your primary residence at 5%, and lets assume a rate increase of 0.75% each year. Now you could take that original $50k acquisition account and immediately put that towards your balance which will reduce your interest only payment down to $208.33. Now each month, you continue to put your $2k away, but now you put it into the HELOC. You will also put the original mortgage payment of $463.12 towards it as well. Now, you will have paid off that HELOC in 22 months paying $2,431 in interest.
Now you can write a check for up to $100k for anything you want like a cash flowing property. Yes, you will reset your HELOC balance, but now you should have an extra +/-$650 cashflow from your last purchase to dump into the HELOC. With your new payment of $3113 per month, you will have paid off that $100k in 35months starting at 6.5% interest, and again increasing at a rate of 0.75% per year.
This formula definitely isn't cut and dry, and is not for everyone. We all know people who are going to buy a boat as soon as they get enough equity, but for us disciplined RE investors, it's a tool that you should know and learn about and consider even if the rates are higher.
The HELOC in your example is a red herring. Assuming you are buying a $100K house and have $50K, you could just use that $50K to reduce your loan to $50K making your payment only $231.56. Then make the same $2464 monthly payment that you would in the HELOC example. The 30 year mortgage would be paid off in 21 months and you will pay only $1737 worth of interest.
The reason you pay it off faster and with less interest is because the HELOC in your example is 5% versus 3.75% on the mortgage.
I say the HELOC is a red herring, because it is a distraction from the real reason mortgage acceleration works. Extra principal payments are what cause loans to pay off faster. Your example is pretty extreme. Half the loan is instantly paid off with the $50K, then the $2000 extra principal is 4X the original payment. Of course you will accelerate with that much extra capital going towards pay down. The point is that it works without the HELOC just the same. In fact better in your example due to the higher interest rate on the HELOC.
- 8yBrian CardwellPro MemberInvestor · Odenton, MD · Member since 2017 · 204 posts · 144 votes
@joe splitrock
I say the HELOC is a tool. Not much different than a hammer. One could use their fist to pound a nail or they could use a hammer or even an automatic hammer. Some tools work better than others .
For me, the use of the HELOC worked as intended while allowing me to still have access to my extra cash I was putting on the Primary loan.
- Sulphur Springs, TX · Member since 2017 · 2 posts · 9 votes8y
All these HELOC acceleration threads end up the same way. They start with a few people pushing how great the HELOC is at accelerating how fast you can pay off your mortgage and how you can save a ton of money. Then smart people come in and prove that there is no (or very VERY slight) difference in using a HELOC compared to just paying extra on your principle. Then the original HELOC advocates will say yeah but you should still do it! Either because they are soliciting money from people about this HELOC payoff plan, or they themselves did it and want to feel like they didn't waste a bunch of time and effort.
- Construction Project Manager · Sycamore, IL · Member since 2015 · 91 posts · 109 votes8y
I agree that if your sole purpose is to pay off the mortgage, simply making extra principal payments may be the way to go. However, future access to that equity is much simpler using a HELOC. Therefore, us real estate investors that have separate accounts for reserves, taxes, insurance can be applied to the HELOC to reduce the principal balance (and therefore the interest paid), until the later date when those bills come due, you write a check out of the HELOC account then repeat the process. It's a way of utilizing your savings to save on interest expenses until the savings is needed.
like @Brian Cardwell said, it is a tool, some prefer to use different tools.
- Investor · Spokane Valley, WA · Member since 2014 · 175 posts · 94 votes8y
Originally posted by @Brian Cardwell:
@joe splitrock
I say the HELOC is a tool. Not much different than a hammer. One could use their fist to pound a nail or they could use a hammer or even an automatic hammer. Some tools work better than others .
For me, the use of the HELOC worked as intended while allowing me to still have access to my extra cash I was putting on the Primary loan.
Well said Brian. I think if this approach had been taken earlier on in the discussion as opposed to the approach that it was mathematically sound and the best way for everyone that you may not have received so much push back.
- Rental Property Investor · East Wenatchee, WA · Member since 2014 · 10k+ posts · 16k+ votes8y
I like the tool metaphor. Leverage in any form is a tool, really. The heloc is a tool with a lot of fine print. When times are good like now, banks don't freeze or call lines, but they have the right to. Don't forget to read the warning stickers on your tools!
My little summary is this. I just punched my higher rate, higher rate investment mortgages in the face. Yes, I used my own money, but it's not like a heloc on my home wouldn't be available to me if I needed extra cash. It's not an either / or argument.
If you are going to pay off a mortgage, pay off one that sucks. Most home mortgages are fixed and below 4%. Why do all this to get rid of the best cheap money on the planet? Surely there's a higher rate or adjustable, callable PITA loan out there to pick on instead. Peace!
- Wholesaler · Noblesville, IN · Member since 2016 · 27 posts · 15 votes8y
@Brian Shurtleff nice professional start to your BP posts.. "then the smart people come in" (rolling my eyes). Again, if you use your HELOC exactly the same as your mortgage you lose! I agree with this. You MUST use the "all in one" strategy. This means, just as @Kyle N. mentioned, ALL of your income and savings goes into the HELOC. For example, I have 10K cash sitting in my savings account for an emergency fund.... well now that is sitting in the HELOC to reduce principal by 10K until I have an emergency. And yes the loan can be called in and bla bla bla... but so can your 30 year fixed rate (actually just happened last year to my best friends dad on his 30 year fixed). So this is just a simple question of how much risk are you willing to take. Should every investor use this technique? Probably not. It's like the hammer example.... the tool only works if you use it for what it is best for... could you churn butter with a hammer? Maybe.. but it's probably not the best way to do it. To use a HELOC to make a difference you have to....
1. HELOC in first position (meaning you bought the home with a HELOC, oh and no closing costs, 3% savings on this part that no one has mentioned yet)
2. ALL income and reserves MUST be put into the HELOC (again, how much risk are you willing to take)
3. Use your HELOC as a checking account and pay ALL bills out of it. (You could even do the credit card thing and use a CC for purchases and then use the HELOC to pay the balance each month)
The jury is still out for me on this whole "chunking" technique. Haven't thought about it. I am promoting the "All in one" strategy with using the HELOC only to purchase the home.
- Wholesaler · Noblesville, IN · Member since 2016 · 27 posts · 15 votes8y
Oh I forgot to add.... the HELOC I am getting ready to use is a 4.95% APR. Just for peoples perspective. This is out of a bank in Indiana and they will let you purchase with an 80% LTV
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