All Forum Posts by: Nick Moriwaki

I haven't posted in a while, but I'll take a shot at this again.

I am definitely on board with the HELOC strategy, however I think there is a lot of misconception when discussing HELOCs. I have definitely learned a lot through these forums and it has changed my view on using a HELOC to pay down a mortgage. Here are a couple of the things I've noticed in recent posts that seem to be misunderstood by the pro-HELOC group.

1) HELOC interest is calculated different than mortgage interest - @Wayne Brooks explained it perfectly.  HELOC interest is calculated the same way as mortgage interest.  If you have a HELOC and an amortized loan and pay the same amount monthly to both, you will end up with the same results.  

2) You need to budget more when using the HELOC strategy - Based on #1 above, this is also not true. Any extra money budgeting when using the HELOC strategy could be directly applied to the mortgage with the same effects.

I've always looked at mortgage vs HELOC debate using a game theory approach with the scenario being a mortgage of X amount, a set amount of liquid cash, and access to a LOC charging the same interest as the mortgage and evaluate each strategy against each other and weigh out the pros and cons as it relates to interest saved, flexibility, convenience, etc. To simplify the scenario, I don't factor in the ability to pursue additional investments with any future money and since I haven't seen that being argued as a potential alternative, I don't think that should be an issue.

So, as I mentioned, part of my thinking has changed as I've discussed this topic on and off for the past year or so. I initially thought the "chunking" strategy of using a LOC to pay large portions of the mortgage off was viable. I've soon come to realize that the counter would be, as mentioned in a previous post, to pay the same amount in liquid cash and take a LOC out as a reserve fund. Paying the same amount in cash instead of using the LOC would win out since you pay no interest to use the cash on hand.

Now here's where the game theory comes into play. Based on problem encountered with the LOC chunk strategy, the goal would be to find a strategy using a LOC that pays the more to the principal than any mortgage strategy can. In the comparison above, any LOC amount that gets applied to the mortgage can be matched by cash and a LOC. But, what if you completely flipped your finances around and put the entire mortgage into a LOC (i.e. - no mortgage) and have all your income/expenses run in and out of that LOC. Then 100% of your money gets applied to the principal (i.e. - when money is obtained it pays down the balance, when money is needed it increases the balance). At no time is money sitting idle in a checking/savings account. The amount applied to principal cannot be matched by any mortgage strategy since to do so would require you to zero your bank account regularly, and since a mortgage is a one way street, this is not feasible. In addition, if your property value is high enough (or remaining principal is low enough), you should have a decent amount of reserves in the form of an available balance on the LOC (e.g. - principal of $300K, LOC of $400K, $100K available).

Of course this is an extreme scenario since you would realistically want to have some cash on hand in a checking or savings, but for those with HELOCs, you know that your available balance is basically the equivalent of having that same balance in a checking or a savings account.  

Thoughts?

Was that 70% reduction recent too?  I have 85% on my investment property.  That was taken out just under 2 years ago though.   

Interesting - I talked to the loan officer (albeit a a couple years ago) and he said they would do up to 90%. I'm thinking maybe it's because it was a first position HELOC, rather than second position? Or could be the out of state thing, but that seems a bit odd.

From what I've heard, Bank of Hawaii will go up to 90% LTV on owner occupant and investment properties. Currently I have one at 85% LTV. The others I've worked with are American Savings (80% LTV on owner occupant and 65% LTV on investment) and First Hawaiian Bank (80% LTV for owner occupant, but not sure about investments).

I would agree that an additional HELOC may be unnecessary and potentially less effective in your case. In my experience in Hawaii, I have worked with 1 bank that offered up to 90% LTV but I think that is very rare. Also, as mentioned, most banks will waive most of the loan origination fees associated with opening a HELOC, but I have not heard of a local bank that waives the appraisal. Doesn't hurt to ask though.

If you've been reading through the posts you'd know that I am a proponent of completely flipping your mortgage into a HELOC (i.e. - take the entire mortgage balance and swap that out for a HELOC with the same balance). I have many posts with a link to my spreadsheet to show the effectiveness of this strategy. When I get a chance I can post it again for you to take a look at and plug in your numbers or if you go through the past few pages of the thread you should be able to find a link.

For background, I started exactly where you are a few years ago - I paid 10% for a studio and was trudging my way along paying a mortgage + PMI for about a year before I found out about this HELOC strategy. I used a PLOC to knock my balance down enough to flip my remaining mortgage balance into a HELOC. The PLOC rate (7.5%) was much higher than my mortgage interest rate, but luckily I was able to take advantage of local promotional rates for HELOCs. Long story short, I used the strategy to save significant amounts of interest and put that immediately to use to get into buy and hold investing, which nets me more cash flow to facilitate the strategy.

But again, do your research and ask questions. Plug in your numbers and play around with the interest rates to see how the interest savings change based on different future scenarios. Also, many have mentioned that some banks may call the loan due if financial circumstances change and/or that they could freeze the LOC if your property value starts to dip. This paired with rising interest rates on variable rate LOCs may or may not be within your risk tolerance for my version of the strategy.

 I hope not....

Josh - I've modified my spreadsheet to show (I think) what everyone is trying to tell you.  Only focus on the mortgage and mortgage + additional columns.  By paying the additional $833.33 to the mortgage each month ($10K a year) you realize the same $100K+ and almost 20 years of savings.  Also, this doesn't eat into the liquid cash that you already had.  Hopefully this helps.

@Shiloh Lundahl - You make some good points that I've seen before in threads regarding HELOCs.  Wanted to address a few to get more information and/or clarify from my perspective. 

1) Maxing out a revolving line of credit, including a HELOC, can negatively effect your credit score

I've seen this argument thrown around a lot. I have a few HELOCs and a PLOC. A couple are maxed out as I rearrange my debt based on interest rates and such, but I have not seen it impact my credit score at all. It shows up on my credit reports but not in the section regarding debt utilization (credit cards). I'm curious where this information comes from because I've asked around and no one else with a HELOC has seen this effect either.

2) A HELOC rate can adjust higher over time and can also be frozen. 

I've seen this one a few times and don't know if I've ever asked, but how does the frozen part work exactly.  I've also seen some posts where people say if anything financially changes, the bank could call the loan due.  I'm wondering how closely the banks would track your financial situation (e.g. - loss of job, value of house, etc...) to even know when to perform these actions and if it matters the balance you are carrying.  Seems like an odd

4) The average person usually doesn’t have the discipline to pay a lot more toward a conventional loan if they don’t have to. Especially if there is fear that they won’t have access to the money if they really needed it.

This is a major reason I advocate for the HELOC strategy. You still have access to the money when you need it while still paying more in the process. The only discipline needed is to not fall into the reverse trap of spending differently now that you have access to all your prior payments.

7) A conventional home loan is some of the cheapest money available. Rather than paying down the mortgage, figuring out how to put your money to its highest and best use may have a substantially greater effect on building wealth than paying down a home mortgage would.

See #4 above.  You keep access to your money to put to the best use at any time, not just when you've saved up enough from income minus mortgage payments.  And that money doesn't have to sit in a savings account earning you nothing until then.  However this is where the risk assessment comes in regarding future returns, interest rates, tax benefits, etc... 

I'd also like to add that this was not an emotional debate for me either. I am very passionate about this strategy because for me it's all in the numbers. I don't need to justify why a B-class property here outperforms your C-class property there. Or why an X-plex unit here outperforms your SFH. If done correctly, the numbers speak for themselves. The parts that can be debated are whether the savings shown are worth the risk associated with the strategy and that's the area I was trying to get to, and which you partly addressed.

For what I’m talking about faster payoff isn’t the ultimate goal. Paying less interest is.  

One thing to keep in mind regading future investments. Everyone points out that taking money out of the HELOC to fund an investment costs you money (5% interest in this case). But everyone seems to overlook that not putting your money into the mortgage costs you money as well (5% savings not realized). I'd much rather save 5% until the point I need the money than give up 5% waiting for that opportunity to present itself.

Exactly, getting a HELOC would be refinancing at that point. Probably at a cost of a few weeks and $1000 - $1500. That's not even getting into potential hurdles in DTI and reserves if you tried to keep up with the first position HELOC strategy by paying additional to your mortgage.

So you're suggesting a potential better option is to wait and get the HELOC later, forgoing the savings until that point, and dealing with the problems listed above?

That's what I'm trying to figure out. Everyone keeps rattling off "simple" counters to the strategy as if the financing just appears or that if you just throw the $50K into the mortgage it functions the same not acknowledging what the resulting scenario looks like. All the while, no one has been able to show that the HELOC strategy I presented isn't simple, or comes with opportunity costs, or anything really. Granted there is an upfront cost (potentially) and has variable interest, but it lowers the balance and keeps your money available. And if you play with the numbers, you'd see that in most scenarios the variable interest doesn't affect the total interest paid as much as you'd think.

I understand that there was a large debate going on regarding a slightly different spin on this strategy, and that the math may prove that strategy to be ineffective, but now that the dust has settled I'm trying to address a variation that I think is a home run and haven't been able to get much response other than that I'm not comparing apples to apples scenarios.   

The only problem is that the HELOC model I laid out cannot be replicated with a mortgage. As I mentioned before, the only way to match the balance is to zero your bank account every month - not reasonable. At some point you have to make a risk-based decision on how low your bank account can be while still being comfortable. The more you keep in the bank account, the bigger the gap in the savings between the HELOC and mortgage pay down strategies.

In addition, by keeping the mortgage, you lock away those extra payments. If an opportunity presents itself you need to refinance to get access to that money again. This costs time and money, something you don't give up when you use the HELOC.

The part where you say "If you have the means and access to financing options to maintain a $50,000 lower balance you will see some significant interest savings" makes me think you're missing how the strategy works. The financing option is just swapping the mortgage for a HELOC - the LTV should be equal or less than the mortgage (unless the property depreciated). And the $50K is just the bank account in this scenario. That's how you maintain the lower balance, by being able to dump that into the HELOC. There is no magic financing or criteria. Dumping the $50K into the mortgage in this scenario would leave you at risk of missing payments if your electricity bill is a few dollars higher than expected.

The reason I say the situation is in the same category as what others are saying is because the concept is the same. The math may not work out if you can match the HELOC chunks, but as the HELOC chunks increase past what your liquid cash can keep up with, the margin starts to rapidly increase. The scenario I provided was the most extreme case of the latter description where the HELOC chunk is the entire balance.