Heloc to pay off mortgage faster

[Drew Cameron]

I recently came across a new strategy that I don't quite understand and it sounds too good to be true. The principal is simple. Use your heloc to pay your mortgage and funnel all your funds in and out of it like a checking account. The interest updates daily so you can pay down principal balance much faster than on a traditional mortgage. With a decreasing principal balance the payments go down each month as you pay it off. Plus you can get rid of other payments by funneling them into your account as well. Has anyone else heard of this? Or has anyone used this successfully?

[Nick Moriwaki]

Chris - I guess I see where you guys are coming from now in regards to the HELOC chunk strategy. To sum up, if the HELOC is less than the cash available, you can always match what the HELOC is paying towards the loan. To be honest, I never really dug too deep into it since I was always a proponent for converting the mortgage to a HELOC.

However I still haven't heard a good counter for my variation that swaps a mortgage for a HELOC. In this scenario, the counter-argument of "just match the HELOC" doesn't hold since you would be advocating for zeroing your bank account every month. So since there is the ability to pay more to the balance there is a net interest savings.

I guess instead of saying that the "interest is calculated daily" I should say "since every day the interest is calculated on a smaller balance" then I save on total interest.  Therefore I save on interest, and can invest in anything the person with the mortgage can.  Thoughts?

[Joshua S.]

Originally posted by @Nick Moriwaki:

Chris - I guess I see where you guys are coming from now in regards to the HELOC chunk strategy. To sum up, if the HELOC is less than the cash available, you can always match what the HELOC is paying towards the loan. To be honest, I never really dug too deep into it since I was always a proponent for converting the mortgage to a HELOC.

However I still haven't heard a good counter for my variation that swaps a mortgage for a HELOC. In this scenario, the counter-argument of "just match the HELOC" doesn't hold since you would be advocating for zeroing your bank account every month. So since there is the ability to pay more to the balance there is a net interest savings.

I guess instead of saying that the "interest is calculated daily" I should say "since every day the interest is calculated on a smaller balance" then I save on total interest.  Therefore I save on interest, and can invest in anything the person with the mortgage can.  Thoughts?

The funny thing about this is that everyone is looking at my HELOC as completely separate because I have that plus the mortgage and your strategy is technically one vehicle. The way I view it is I "installed" a HELOC on the top 5% or so of my mortgage which allows me to do the same thing except the rest of my mortgage is not exposed to a variable rate or a freeze or anything. No disrespect to your strategy, Nick, but as you said, it's far more aggressive (and therefore may yield better results), but also comes with those additional risks. I can bail out of the strategy at any point, which was a large selling point to me and to an even greater extent my wife. It also cost me nothing to do because my origination fees were waived. If change my mind that it's not working well enough, I pay it off and let it sit there as backup credit at zero cost.

Anyway, I think the bottom line is whether you do it your way or mine, you are getting more out of your money vs leaving it in a checking account. Maybe I didn't articulate that perfectly, but when I brought it up everyone slammed me pretty hard and it turned into a troll-fest from the word go instead of trying to understand each other.

Since hopefully everyone is ready to return to being respectful, maybe I can clarify a little bit. When I said you skip over payments, you guys jumped on that, because you say that the savings comes from your interest payment dropping and then you're saving money going forward (my understanding). In my case, when I pay $10,000 my interest portion drops by about $35 and principal goes up by the same amount. $35 times the rest of the months in my loan is $11,000. But when I add the principal portions that I "skipped" it equals the same amount. 

So, what I'm getting at is to me this is like six of one, half dozen of the other. When I say I skipped payments, I just mean that I saved on interest by paying extra and to me that's the easiest way to explain it. That's why I introduced the calculators. Because whether you use one of the above descriptions or you prefer to say the tooth fairy puts it under your pillow because you understand it even less than I do, YOU'RE SAVING INTEREST BY PAYING EARLY. I would also argue that the $35 is no longer going toward interest, but it's also being applied to your principal, which allows you to pay down the loan even faster without doing anything to your payment. Maybe this is one part of the scenario that your hand calculations are missing. All I know is when I plug it into the calculators it spits out $100,000 / 20 year savings and I haven't seen anyone who is willing to cop to that because they are so focused on "all interest is calculated the same, you're just swapping debt, etc.". Chris, to your point, I understand that it's like a game of whack-a-mole, but now at this point it's so simple that it boils down to one thing. The calculators are correct on the savings no matter how you want to explain it and we all agree that the cost of the HELOC in my scenario is around $40/month, so if someone is paying a nominal fee to save that kind of money, why can't you accept that? Or at least address it directly instead of trying to turn an apple into an orange like Nick said? Forget about rates and just explain why it's bad to save $100,000 and 20 years if you have to pay a $40/month fee to make it work for your family. Please, someone explain that to me.

[Joshua S.]

Originally posted by @Justin H.:

Originally posted by @Joshua S.:

You tell me what I'm missing. 

You tell me. I just ran the same numbers you did through the Quicken Loans calculator and came up with wildly different results. Lets use your Quicken Loans calculator example of $200k mortgage @ 4% interest plus a $20k available HELOC @ 4% interest.

.

Scenario 1 - The HELOC Method: Your mortgage would look like this...

But you also need to add the HELOC repayment to your monthly costs, which means repaying $10k @ 4% within 1 year, looks for the first 11 years would look like this each year...

Now since you'll be making one final $10k payment right before the end of the mortgage, you can now repay it with the full funding previously split between your HELOC and mortgage, which would look like this...

So paying off the last $10k from the HELOC takes an additional 6 months after the end of the mortgage. So months of payments saved is 219. The HELOC interest paid (217.99 * 11 + 133 = 2530.89) must be subtracted from the Mortgage interest saved (95267.33 - 2530.89 = 92736.44). During this time, your additional liquid funds available in the HELOC are as low as $10k during the year.

.

Scenario 2 - The Mortgage Method: If you can afford an additional 851.50 every month above and beyond the mortgage payment in Scenario 1, then you can do likewise in Scenario 2, as both are utilizing the HELOC for liquid reserves and thus allowing 100% of discretionary income to also be applied to the mortgage each month. So the mortgage would simply look like this...

Notice how many fewer steps (calculations) are involved to pay off all associated debts in Scenario 2. Notice the additional 1 month of payments saved before all associated debts are paid off in Scenario 2. Notice the additional 490.86 of total interest saved before all associated debts are paid off in Scenario 2. Oh yea, and notice that not once does available liquid funds from the HELOC dip below the full $20k in Scenario 2.

These are the results for the repayment of ALL associated debts incurred, based on the calculators that you specifically hold in such high regard...Even over advanced excel spreadsheets that can be much more exactingly tailored to suit specific uncommon situation like the so-called "HELOC method", and even though these simplistic calculators were never designed or intended to handle such irregularities. When correctly using the calculator that you recommended, so as to not let poor mathematical inputs obfuscate the truth with equally poor mathematical outputs, this "HELOC method" does not show one single advantage over maintaining a $0 balance HELOC and applying the same total monthly discretionary funds simply and directly to the mortgage on a monthly basis.

Justin, we've already discussed this at length. If you find it easier to dump all your discretionary income on the mortgage and use the HELOC as backup, that's fine with everyone here, but the point of doing it the other way is you are putting all of your income and bills against the HELOC, which keeps the average daily balance lower and saves on interest. Example - make the $10,000 to your mortgage, get a paycheck that brings your balance down to $7000, pay a bill and go back up to $7500, get another paycheck, pay another bill, etc. - ending balance is $9000 because you bring in $1000 more than you spend each month, but your ADB was $6500 and that's what you pay interest on. Plus, you don't have to determine how much discretionary to put toward the mortgage each month, because it's done automatically, which is usually easier for people.

So, your money is working for you in two ways. The money you DON'T use throughout the month is bringing your month end balance down and paying off the HELOC gradually over the course of the year, but you can also take it back out if something comes up. The money you DO use throughout the month is bringing down your ADB and saving you on interest until you need it. Those are the advantages. And for those advantages you pay the interest charges on the HELOC, which depending on rate and ADB should be $20-$60/month. Skip some lattes or a dinner out each month and pay for it that way if it's a problem, but you save more on interest than you'll spend running it, so I'm still going out to dinner worry free.

Another way to look at it is that you're paying that $2500 over 11 years as a fee for having your money work for you full time instead of sitting on the couch in your checking account. Many people pay for luxuries far beyond this and if I need to pay $2500 to more conveniently save $95,000 I'm in. If you disagree with paying for the convenience, that's fine, but are you putting all your discretionary toward your mortgage currently? If not, why not? Probably because you'd feel naked with no money in your checking account every month, right? Try to actually imagine doing it instead of actually calculating it. It doesn't seem fun at all to me.

[Marcus Johnson]

Remember the middleman is always in it to make a buck so have fun paying those fees.

[Justin H.]

@Nick Moriwaki

As clearly demonstrated by 'Scenario 2' (accelerated mortgage paydown + $0 balance HELOC reserve) in my above post:

@Nick Moriwaki - There is absolutely zero advantage to using up available credit as a checking account, rather than just using...A checking account.

.

@Joshua S. - In and of itself it's not 'bad', but you're just accomplishing the same goal as other available methods using the financial equivalent of a rube goldberg machine.  Contrary to your claims it provides zero advantages over the much more simple and direct available alternative.  You can realize the exact same $100k and 20 year savings without jumping through any hoops. 

Your average daily balance is your mortgage + HELOC is essentially the same either way, since you cannot pay the combination of debt down any faster than your income will allow.

[Joshua S.]

Originally posted by @Justin H.:

@Nick Moriwaki

As clearly demonstrated by 'Scenario 2' (accelerated mortgage paydown + $0 balance HELOC reserve) in my above post:

@Nick Moriwaki - There is absolutely zero advantage to using up available credit as a checking account, rather than just using...A checking account.

.

@Joshua S. - In and of itself it's not 'bad', but you're just accomplishing the same goal as other available methods using the financial equivalent of a rube goldberg machine.  Contrary to your claims it provides zero advantages over the much more simple and direct available alternative.  You can realize the exact same $100k and 20 year savings without jumping through any hoops. 

Your average daily balance is your mortgage + HELOC is essentially the same either way, since you cannot pay the combination of debt down any faster than your income will allow.

Financial Rube Goldberg machine, I like that. :) So, is this what you do currently? You put all of your discretionary on your mortgage every month?

[Nick Moriwaki]

Originally posted by @Justin H.:

@Nick Moriwaki

As clearly demonstrated by 'Scenario 2' (accelerated mortgage paydown + $0 balance HELOC reserve) in my above post:

@Nick Moriwaki - There is absolutely zero advantage to using up available credit as a checking account, rather than just using...A checking account.

.

@Joshua S. - In and of itself it's not 'bad', but you're just accomplishing the same goal as other available methods using the financial equivalent of a rube goldberg machine.  Contrary to your claims it provides zero advantages over the much more simple and direct available alternative.  You can realize the exact same $100k and 20 year savings without jumping through any hoops. 

Your average daily balance is your mortgage + HELOC is essentially the same either way, since you cannot pay the combination of debt down any faster than your income will allow.

Justin - see my spreadsheet on page 10 of this thread. The HELOC strategy I lay out is the same thing others are mentioning, except the chunk is the entire mortgage (i.e. - mortgage goes away and only carry the HELOC). Then instead of keeping a positive checking account balance I keep a smaller HELOC balance by dumping the money from the checking into the HELOC. I don't lose access to that money since it's in a revolving line and my balance is smaller than any mortgage balance given the same parameters so therefore the interest accrued is less. This compounds over time for a significant savings. Take a look.

[Chris May]

@Nick Moriwaki I'm curious. What's the rate on your HELOC? I assume it's variable, right?

[Justin H.]

@Joshua S. - Generally speaking, yes. I do a variation on the noted method, but modified for my personal risk tolerance and investment goals...And in the same way that I would inherently modify the so-called 'HELOC method' as well.

@Nick Moriwaki - I'll have to go back and take a closer look at your spreadsheet tonight. I think I see what you're saying though. I would argue that while you don't lose access to your past monthly payments, you have lost access to your future monthly payments by tying up the full value of your mortgage in your HELOC. So initially you have much less available liquid funding than towards the end. Where as the method I describe provides equal available liquid funding for the life of the debt. As such, you are trading interest savings for lost opportunity, especially in the earlier portion of the repayment, which also compounds greatly over time. Of course, this also necessitates locked equal terms on the HELOC as on the conventional mortgage, which is not the norm in my experience, lest the compounding interest savings rapidly disappear.

[Nick Moriwaki]

Originally posted by @Chris May:

@Nick Moriwaki I'm curious. What's the rate on your HELOC? I assume it's variable, right?

This is the "wait there's more" part, at least for Hawaii people.  Pretty much all HELOCs come with a promotional rate as long as you basically set up auto pay.  These rates are sometimes dependent on how long you want it to be locked in for (e.g. - 0.75% for 1 year, 1.75% for 2 years, 2.75% for 3 years).  Others are fixed increments - 1% first year, 2% second year, then variable.  The great thing is you can leverage your options against the bank to see if they will increase the length of time they will give you the promo rate since you can always just refinance to another bank that will. 

Pair this with what I laid out in the spreadsheet and you can do some major damage to the amount of interest you pay on your loan. 

[Joshua S.]

Originally posted by @Justin H.:

@Joshua S. - Generally speaking, yes. I do a variation on the noted method, but modified for my personal risk tolerance and investment goals...And in the same way that I would inherently modify the so-called 'HELOC method' as well.

@Nick Moriwaki - I'll have to go back and take a closer look at your spreadsheet tonight. I think I see what you're saying though. I would argue that while you don't lose access to your past monthly payments, you have lost access to your future monthly payments by tying up the full value of your mortgage in your HELOC. So initially you have much less available liquid funding than towards the end. Where as the method I describe provides equal available liquid funding for the life of the debt. As such, you are trading interest savings for lost opportunity, especially in the earlier portion of the repayment, which also compounds greatly over time. Of course, this also necessitates locked equal terms on the HELOC as on the conventional mortgage, which is not the norm in my experience, lest the compounding interest savings rapidly disappear.

So, you wait for your funds to come in, pay all your bills, and then put the surplus into the mortgage. In the HELOC strategy, you borrow the money now and start saving mortgage interest immediately and pay it back as your funds come in, so speed is another advantage.

Again, I respect the other way of doing it, but saying there are no advantages to the HELOC version is shortsighted. Imagine the HELOC was zero interest / free and you were able to do what I'm describing. Borrow the money now instead of waiting to earn it and using what's left after you pay your bills, have your money work for you all month instead of sitting in a checking account, etc. - those are very clear advantages over doing it with your own funds.

What you seem to be saying is that since there's a nominal charge for doing it this way it negates the advantages and that's simply not true. It'd be like saying, "You know, I love my car and there could be a lot of convenience there. I get to work dry and all that, but there's a cost, so there's really no convenience. The cost cancels out the convenience." But we all know that's not true. You are PAYING TO HAVE THE CONVENIENCE. That's all I'm doing. I'm paying for the convenience of building equity faster without using my own funds right now and having my money work for me full time to bring my debt down. If you don't want to pay for the convenience, great, but not seeing the reality of what's taking place is a mistake on your part.

[Chris May]

@Joshua S. The things we're talking about regarding pros and cons of HELOCs are valid. Everyone's financial situation is different and different strategies will work better for different people.

The part that's like nails on a chalkboard (and what this thread was originally about) is this comment from you: 

"In the HELOC strategy, you borrow the money now and start saving mortgage interest immediately and pay it back as your funds come in, so speed is another advantage."

This is what we keep harping on. When you transfer a loan balance, you do not save any interest immediately. The future interest expense on a loan is a deferred liability. Moving the debt to a different loan product just moves the interest liability with it.

So this $21,000 "interest savings" you're seeing on the calculator is really just you moving $21,000 of interest expense to the HELOC. You don't bring down the future interest liability balance until you pay the HELOC principal.

[Chris May]

Originally posted by @Nick Moriwaki:

Originally posted by @Chris May:

@Nick Moriwaki I'm curious. What's the rate on your HELOC? I assume it's variable, right?

This is the "wait there's more" part, at least for Hawaii people.  Pretty much all HELOCs come with a promotional rate as long as you basically set up auto pay.  These rates are sometimes dependent on how long you want it to be locked in for (e.g. - 0.75% for 1 year, 1.75% for 2 years, 2.75% for 3 years).  Others are fixed increments - 1% first year, 2% second year, then variable.  The great thing is you can leverage your options against the bank to see if they will increase the length of time they will give you the promo rate since you can always just refinance to another bank that will. 

Pair this with what I laid out in the spreadsheet and you can do some major damage to the amount of interest you pay on your loan. 

If you're saving several interest percentage points on your HELOC that is a massive advantage. Nothing really to do with HELOCs specifically, but a leg up nonetheless.

What do the interest rates reset to? I can't really picture how that's a winning business model for the banks if you can just keep refinancing into new HELOCs, but I'm also not even close to expert on lending so I assume there's a piece of this I'm missing.

Wouldn't everyone just keep opening new HELOCs and moving the balances over? Seems like banks would be losing money lending at below prime (Fed) rates.

[Jeremy Z.]

Originally posted by @Justin H.:

@Nick Moriwaki

As clearly demonstrated by 'Scenario 2' (accelerated mortgage paydown + $0 balance HELOC reserve) in my above post:

@Nick Moriwaki - There is absolutely zero advantage to using up available credit as a checking account, rather than just using...A checking account.

.

@Joshua S. - In and of itself it's not 'bad', but you're just accomplishing the same goal as other available methods using the financial equivalent of a rube goldberg machine.  Contrary to your claims it provides zero advantages over the much more simple and direct available alternative.  You can realize the exact same $100k and 20 year savings without jumping through any hoops. 

Your average daily balance is your mortgage + HELOC is essentially the same either way, since you cannot pay the combination of debt down any faster than your income will allow.

 This thread is dizzying, so forgive me if I've missed something or am just throwing a curveball here...

Your assertions are correct when accounting for mortgage payments only. However, this HELOC method can work for some people if they use it for a considerable amount of other expenses. Let their income sit in the HELOC rather than a checking account earning nothing or next to nothing and they can lower their average daily balance and see some savings over time. Am I overlooking something?

Now granted, I'm sure a lot of people are sold on this method without having enough savings or additional income to make this method worthwhile. And others are sold on getting a HELOC as a magic bullet for their mortgage payments when they could just use their bank account like you have demonstrated with visuals. But "gaming the average daily balance" as others have called it actually can work in certain situations.

[Joshua S.]

Originally posted by @Chris May:

@Joshua S. The things we're talking about regarding pros and cons of HELOCs are valid. Everyone's financial situation is different and different strategies will work better for different people.

The part that's like nails on a chalkboard (and what this thread was originally about) is this comment from you: 

"In the HELOC strategy, you borrow the money now and start saving mortgage interest immediately and pay it back as your funds come in, so speed is another advantage."

This is what we keep harping on. When you transfer a loan balance, you do not save any interest immediately. The future interest expense on a loan is a deferred liability. Moving the debt to a different loan product just moves the interest liability with it.

So this $21,000 "interest savings" you're seeing on the calculator is really just you moving $21,000 of interest expense to the HELOC. You don't bring down the future interest liability balance until you pay the HELOC principal.

That's fine, but again, I think you're splitting hairs. If you want to call it a deferred liability, that's fine. So, I move the interest liability over to the HELOC, but then I'm able to aggressively pay it down by doing what I used to do with my checking account - income and bills going in and out.

It seems like you think you move the "liability" to the HELOC and then pay it off at the same rate, but that's the part you're neglecting. You're not paying it down at the same rate of speed. If that $10,000 was in the mortgage it would be charging x amount of interest because it's there all month. When the $10,000 is in the HELOC you may only pay interest on $6000 or $8000 or $4000 because you're able to keep your ADB lower. So, when you say that you're just transferring liability from one vehicle to another, you're not. You're transferring debt to a place where you can depress the daily balance through your normal banking routine. And you're transferring to a place where you can automatically put all of your discretionary income toward paying it down through your normal banking.

And then when you say you're just moving the $21,000 interest expense to the HELOC, I don't get that at all. Let's say over the course of the year I'm paying it off and as the balance goes down my interest charges look like this. I'm using 8% interest so it's not like a rate gaming thing.

$10,000 x .006666 = $67 in month one. 

$1000 x .006666 = $7 in month ten. 

When I average those out I get $37/month over the course of the year. Obviously, that's $370 total interest cost to pay off the $10,000 over ten months. And keep in mind, none of this takes into account having a lower ADB, so this is an absolute maximum cost.

I honestly don't know what we're missing, but this is the crux of it for me. When you say you move the $21,000 interest cost to the HELOC, but I'm calculating the cost as $370 total, one of us is missing something. But this math is correct, right? That's what I've been talking about. You seem to be blindly saying that it's the same, you're just moving the balance to another vehicle and it will all equal out, but when you do the interest calculations on the $10,000 in the HELOC, even at 8% you still come out way ahead. So, please, work from this perspective. If it's not correct, that's fine, but so far I'm seeing that $21,000 savings and can only find a total cost of $370 for borrowing the money to do it. How would the $10,000 cost $21,000 interest in the HELOC?

[Joshua S.]

Originally posted by @Joshua S.:

Originally posted by @Chris May:

@Joshua S. The things we're talking about regarding pros and cons of HELOCs are valid. Everyone's financial situation is different and different strategies will work better for different people.

The part that's like nails on a chalkboard (and what this thread was originally about) is this comment from you: 

"In the HELOC strategy, you borrow the money now and start saving mortgage interest immediately and pay it back as your funds come in, so speed is another advantage."

This is what we keep harping on. When you transfer a loan balance, you do not save any interest immediately. The future interest expense on a loan is a deferred liability. Moving the debt to a different loan product just moves the interest liability with it.

So this $21,000 "interest savings" you're seeing on the calculator is really just you moving $21,000 of interest expense to the HELOC. You don't bring down the future interest liability balance until you pay the HELOC principal.

That's fine, but again, I think you're splitting hairs. If you want to call it a deferred liability, that's fine. So, I move the interest liability over to the HELOC, but then I'm able to aggressively pay it down by doing what I used to do with my checking account - income and bills going in and out.

It seems like you think you move the "liability" to the HELOC and then pay it off at the same rate, but that's the part you're neglecting. You're not paying it down at the same rate of speed. If that $10,000 was in the mortgage it would be charging x amount of interest because it's there all month. When the $10,000 is in the HELOC you may only pay interest on $6000 or $8000 or $4000 because you're able to keep your ADB lower. So, when you say that you're just transferring liability from one vehicle to another, you're not. You're transferring debt to a place where you can depress the daily balance through your normal banking routine. And you're transferring to a place where you can automatically put all of your discretionary income toward paying it down through your normal banking.

And then when you say you're just moving the $21,000 interest expense to the HELOC, I don't get that at all. Let's say over the course of the year I'm paying it off and as the balance goes down my interest charges look like this. I'm using 8% interest so it's not like a rate gaming thing.

$10,000 x .006666 = $67 in month one. 

$1000 x .006666 = $7 in month ten. 

When I average those out I get $37/month over the course of the year. Obviously, that's $370 total interest cost to pay off the $10,000 over ten months. And keep in mind, none of this takes into account having a lower ADB, so this is an absolute maximum cost.

I honestly don't know what we're missing, but this is the crux of it for me. When you say you move the $21,000 interest cost to the HELOC, but I'm calculating the cost as $370 total, one of us is missing something. But this math is correct, right? That's what I've been talking about. You seem to be blindly saying that it's the same, you're just moving the balance to another vehicle and it will all equal out, but when you do the interest calculations on the $10,000 in the HELOC, even at 8% you still come out way ahead. So, please, work from this perspective. If it's not correct, that's fine, but so far I'm seeing that $21,000 savings and can only find a total cost of $370 for borrowing the money to do it. How would the $10,000 cost $21,000 interest in the HELOC?

Here's another way to think about the questions here. If the $10,000 was on your mortgage, it would take at least two years to pay down (my current mortgage / $21,000 discussion). On another loan I have, I'm looking at the amo table right meow and it took 82 payments / almost 7 years to pay down $10,000 (before I learned about this strategy).

On that loan the interest portion during that 82 payments ranged from $299 to $261 (avg $280). $280 x 82 = $22,960 in total interest costs over that time. Now I can pay off the $10,000 faster at the interest cost describe above - max $370. 

Again, I don't know WHY the costs are so different, but I'm starting to think that the speed may be the factor you are missing. 

[Justin H.]

Originally posted by @Joshua S.: 

On that loan the interest portion during that 82 payments ranged from $299 to $261 (avg $280). $280 x 82 = $22,960 in total interest costs over that time. Now I can pay off the $10,000 faster at the interest cost describe above - max $370.

Again, I don't know WHY the costs are so different...

They key to understanding 'why' lies in the answer to this classic financial riddle:

Three people check into a hotel room. The clerk says the bill is $30, so each guest pays $10. Later the clerk realizes the bill should only be $25. To rectify this, he gives the bellhop $5 to return to the guests. On the way to the room, the bellhop realizes that he cannot divide the money equally. As the guests didn't know the total of the revised bill, the bellhop decides to just give each guest $1 and keep $2 as a tip for himself. Each guest got $1 back, so now each guest only paid $9, bringing the total paid to $27. The bellhop has $2. And $27 + $2 = $29. So, if the guests originally handed over $30, what happened to the remaining $1?

[Chris May]

@Joshua S. To be fair, you're at least partially correct. You're not moving $21,000 of future interest liability. I'm using that as a shorthand for "future interest liability on a balance of $10,000". In reality, the $10,000 sitting on your mortgage has a potential  future interest cost of $0 - $21,000, depending on when you pay the principal. The $10,000 sitting on your HELOC has a potential future interest cost of $0 - infinite dollars, depending on when you pay the principal. That's why you shouldn't focus on what that amortization calculator is telling you. It's not giving you an apples-to-apples comparison with the HELOC. 

You really need to look at it on a per-period basis otherwise the comparison doesn't make sense.

Here is 6 months of payments on a 200k mortgage:

Month	Begin	PMT	Interest	Principal	Extra	End
1	200,000.00	(1,073.64)	(833.33)	(240.31)	-	199,759.69
2	199,759.69	(1,073.64)	(832.33)	(241.31)	-	199,518.38
3	199,518.38	(1,073.64)	(831.33)	(242.32)	-	199,276.06
4	199,276.06	(1,073.64)	(830.32)	(243.33)	-	199,032.74
5	199,032.74	(1,073.64)	(829.30)	(244.34)	-	198,788.40
6	198,788.40	(1,073.64)	(828.28)	(245.36)	-	198,543.04

Here's that same mortgage with a 10,000 payment from the HELOC to the mortgage in month one:

Month	Begin	PMT	Interest	Principal	Extra	End
1	200,000.00	(1,073.64)	(833.33)	(240.31)	(10,000.00)	189,759.69
2	189,759.69	(1,073.64)	(790.67)	(282.98)	-	189,476.71
3	189,476.71	(1,073.64)	(789.49)	(284.16)	-	189,192.56
4	189,192.56	(1,073.64)	(788.30)	(285.34)	-	188,907.21
5	188,907.21	(1,073.64)	(787.11)	(286.53)	-	188,620.68
6	188,620.68	(1,073.64)	(785.92)	(287.72)	-	188,332.96

And here is the HELOC interest:

Month	Begin	PMT	Interest	Principal	End
1	10,000.00	-	(41.67)	-	10,000.00
2	10,000.00	-	(41.67)	-	10,000.00
3	10,000.00	-	(41.67)	-	10,000.00
4	10,000.00	-	(41.67)	-	10,000.00
5	10,000.00	-	(41.67)	-	10,000.00
6	10,000.00	-	(41.67)	-	10,000.00

Notice anything about the combined interest payments for each scenario? They're essentially identical. The small difference is really just the timing of the payment within the period. You just shifted ~$42 of interest from the mortgage to the HELOC. If you make a $10,000 payment in month 4 to the HELOC and pay off the balance, it will have the same effect as making a $10,000 mortgage payment of month 4.

But wait! What about the impact of the daily average balance calculation??? Agreed, that is the only "real" source of savings in this scenario. Your example of maybe only having a ADB of $4,000 on that $10,000 is pretty unrealistic, but I'll entertain it. Instead of paying interest on $10,000, you'd pay interest on $4,000, or $16.67. So this elaborate plan saved you r * (ADB - ending balance) = $25 (and, again, bringing down your ADB that much is pretty far fetched, though I'll concede it's possible for high income folks).

Earlier in the thread you said it doesn't even really matter what your interest rate is and you suggested an 8% HELOC. Your interest on that $4,000 ADB would be $26.67 ($15 savings). If your daily average balance was a more realistic $7000, you lost $5! (interest = $46.67)

So yes, you can save a few dollars here and there, but only by gaming the daily average balance formula. The interest rate on the HELOC is very important and the extent to which you game the daily average balance is the only thing actually saving money. 

[Joshua S.]

Originally posted by @Justin H.:

Originally posted by @Joshua S.: 

On that loan the interest portion during that 82 payments ranged from $299 to $261 (avg $280). $280 x 82 = $22,960 in total interest costs over that time. Now I can pay off the $10,000 faster at the interest cost describe above - max $370.

Again, I don't know WHY the costs are so different...

They key to understanding 'why' lies in the answer to this classic financial riddle:

Three people check into a hotel room. The clerk says the bill is $30, so each guest pays $10. Later the clerk realizes the bill should only be $25. To rectify this, he gives the bellhop $5 to return to the guests. On the way to the room, the bellhop realizes that he cannot divide the money equally. As the guests didn't know the total of the revised bill, the bellhop decides to just give each guest $1 and keep $2 as a tip for himself. Each guest got $1 back, so now each guest only paid $9, bringing the total paid to $27. The bellhop has $2. And $27 + $2 = $29. So, if the guests originally handed over $30, what happened to the remaining $1?

You might be psychic, Justin. I was literally thinking about this last night, but I know it as a pizza guy stealing the $2.

[Joshua S.]

Originally posted by @Chris May:

@Joshua S. To be fair, you're at least partially correct. You're not moving $21,000 of future interest liability. I'm using that as a shorthand for "future interest liability on a balance of $10,000". In reality, the $10,000 sitting on your mortgage has a potential  future interest cost of $0 - $21,000, depending on when you pay the principal. The $10,000 sitting on your HELOC has a potential future interest cost of $0 - infinite dollars, depending on when you pay the principal. That's why you shouldn't focus on what that amortization calculator is telling you. It's not giving you an apples-to-apples comparison with the HELOC. 

You really need to look at it on a per-period basis otherwise the comparison doesn't make sense.

Here is 6 months of payments on a 200k mortgage:

Month	Begin	PMT	Interest	Principal	Extra	End
1	200,000.00	(1,073.64)	(833.33)	(240.31)	-	199,759.69
2	199,759.69	(1,073.64)	(832.33)	(241.31)	-	199,518.38
3	199,518.38	(1,073.64)	(831.33)	(242.32)	-	199,276.06
4	199,276.06	(1,073.64)	(830.32)	(243.33)	-	199,032.74
5	199,032.74	(1,073.64)	(829.30)	(244.34)	-	198,788.40
6	198,788.40	(1,073.64)	(828.28)	(245.36)	-	198,543.04

Here's that same mortgage with a 10,000 payment from the HELOC to the mortgage in month one:

Month	Begin	PMT	Interest	Principal	Extra	End
1	200,000.00	(1,073.64)	(833.33)	(240.31)	(10,000.00)	189,759.69
2	189,759.69	(1,073.64)	(790.67)	(282.98)	-	189,476.71
3	189,476.71	(1,073.64)	(789.49)	(284.16)	-	189,192.56
4	189,192.56	(1,073.64)	(788.30)	(285.34)	-	188,907.21
5	188,907.21	(1,073.64)	(787.11)	(286.53)	-	188,620.68
6	188,620.68	(1,073.64)	(785.92)	(287.72)	-	188,332.96

And here is the HELOC interest:

Month	Begin	PMT	Interest	Principal	End
1	10,000.00	-	(41.67)	-	10,000.00
2	10,000.00	-	(41.67)	-	10,000.00
3	10,000.00	-	(41.67)	-	10,000.00
4	10,000.00	-	(41.67)	-	10,000.00
5	10,000.00	-	(41.67)	-	10,000.00
6	10,000.00	-	(41.67)	-	10,000.00

Notice anything about the combined interest payments for each scenario? They're essentially identical. The small difference is really just the timing of the payment within the period. You just shifted ~$42 of interest from the mortgage to the HELOC. If you make a $10,000 payment in month 4 to the HELOC and pay off the balance, it will have the same effect as making a $10,000 mortgage payment of month 4.

But wait! What about the impact of the daily average balance calculation??? Agreed, that is the only "real" source of savings in this scenario. Your example of maybe only having a ADB of $4,000 on that $10,000 is pretty unrealistic, but I'll entertain it. Instead of paying interest on $10,000, you'd pay interest on $4,000, or $16.67. So this elaborate plan saved you r * (ADB - ending balance) = $25 (and, again, bringing down your ADB that much is pretty far fetched, though I'll concede it's possible for high income folks).

Earlier in the thread you said it doesn't even really matter what your interest rate is and you suggested an 8% HELOC. Your interest on that $4,000 ADB would be $26.67 ($15 savings). If your daily average balance was a more realistic $7000, you lost $5! (interest = $46.67)

So yes, you can save a few dollars here and there, but only by gaming the daily average balance formula. The interest rate on the HELOC is very important and the extent to which you game the daily average balance is the only thing actually saving money. 

Ok, thanks, I appreciate you finally giving way to some of my points. And the calculations work out, I can see that it's correct in the mathematical sense and when you add the HELOC interest to the recalculated mortgage interest it adds up to the old interest amount. Great job explaining that, I get that now. But I guess what I'm asking now is how do you reconcile that with the savings we agreed on seeing on the calculators? You just said last time that you see $21,000 savings on the calculator, but I'm just swapping that interest over onto the HELOC and now it's all washing out for some reason because I showed you the $21,000 in HELOC interest wasn't possible. I mean, that's legitimately what just happened, so I don't really understand.

So, apparently the savings are technically at the end when you cut off the mortgage early, what does that look like? Months 340-360 on one table and nothing on the other table, because the mortgage is paid off, right? Or maybe the savings just happen along the way every month? You can try to explain that part if you want, but my point is that it doesn't really matter in the real world how the savings are explained as long as you get them. That's why I was saying that the bottom line is everyone agrees there are a lot of savings in paying extra principal, but when the HELOC is added to the mix it suddenly becomes a magic trick that won't work.

Let's walk slowly through this to make sure I understand. Putting aside the HELOC completely - if I showed up on this thread and said that my wife and I get a total of $10,000 in bonuses every year and we decided to use them to pay extra principal, would you agree that it saves $100,000 and 20 years off of our mortgage?

[Jeremy Z.]

@Joshua S.

"Everyone agrees there are a lot of savings in paying extra principal, but when the HELOC is added to the mix it suddenly becomes a magic trick that won't work."

I don't believe anyone here has claimed this HELOC approach doesn't work. Just that it is unnecessary for achieving the accelerated payoff. We have argued that it is not a magic bullet.

[Nick Moriwaki]

Originally posted by @Justin H.:

@Joshua S. - Generally speaking, yes. I do a variation on the noted method, but modified for my personal risk tolerance and investment goals...And in the same way that I would inherently modify the so-called 'HELOC method' as well.

@Nick Moriwaki - I'll have to go back and take a closer look at your spreadsheet tonight. I think I see what you're saying though. I would argue that while you don't lose access to your past monthly payments, you have lost access to your future monthly payments by tying up the full value of your mortgage in your HELOC. So initially you have much less available liquid funding than towards the end. Where as the method I describe provides equal available liquid funding for the life of the debt. As such, you are trading interest savings for lost opportunity, especially in the earlier portion of the repayment, which also compounds greatly over time. Of course, this also necessitates locked equal terms on the HELOC as on the conventional mortgage, which is not the norm in my experience, lest the compounding interest savings rapidly disappear.

I don't quite follow what you're saying about the liquid funding, but let me know if you still think so after looking at the spreadsheet.  

You are correct about the interest rates though. The spreadsheet allows for modifying the rate each year to see how vulnerable you are. There are usually clauses in HELOC paperwork that limits the rate increase from year to year so it limits the risk a little.

[Nick Moriwaki]

Originally posted by @Chris May:

Originally posted by @Nick Moriwaki:

Originally posted by @Chris May:

@Nick Moriwaki I'm curious. What's the rate on your HELOC? I assume it's variable, right?

This is the "wait there's more" part, at least for Hawaii people.  Pretty much all HELOCs come with a promotional rate as long as you basically set up auto pay.  These rates are sometimes dependent on how long you want it to be locked in for (e.g. - 0.75% for 1 year, 1.75% for 2 years, 2.75% for 3 years).  Others are fixed increments - 1% first year, 2% second year, then variable.  The great thing is you can leverage your options against the bank to see if they will increase the length of time they will give you the promo rate since you can always just refinance to another bank that will. 

Pair this with what I laid out in the spreadsheet and you can do some major damage to the amount of interest you pay on your loan. 

If you're saving several interest percentage points on your HELOC that is a massive advantage. Nothing really to do with HELOCs specifically, but a leg up nonetheless.

What do the interest rates reset to? I can't really picture how that's a winning business model for the banks if you can just keep refinancing into new HELOCs, but I'm also not even close to expert on lending so I assume there's a piece of this I'm missing.

Wouldn't everyone just keep opening new HELOCs and moving the balances over? Seems like banks would be losing money lending at below prime (Fed) rates.

Well, the HELOC allows you to do what I laid out in the spreadsheet. The mortgage version (ARM) does not since you would still not be able to zero your bank account.

The interest rate after the promotion reverts back to the Fed rate + a percentage (I think 2%) but never less than 4.5%.  And there are limits on rate increases year to year and the cap based on the initial variable rate if I remember correctly.  

I believe the reason lies with the way most people in Hawaii have their finances structured. Because the housing prices are so high here, most people carry sizable mortgages with a decent amount of equity. With the promotional rates, the banks entice people to take out decent sized HELOCs (second position) for renovations and such. Because the HELOCs require interest only payments and the starting interest is so low, people just pay small amounts not realizing how the future rates will affect them (also not knowing how easy it is to move from bank to bank). This is similar to how I imagine people get into credit card debt by seeing the minimum payment amount of $80 and not realizing how astronomical that is on say, $5000 of debt. I think a large majority of people know to stay away from credit card debt, but don't realize that HELOCs function the same way. Additionally, since the banks make you sign up for auto pay to obtain the HELOC, I'm guessing they're hoping that you just forget about monitoring the payments when the interest rate reverts back to the variable rate. Also, conventional thinking is that variable rates are the devil, so no one would even consider swapping their entire $500K mortgage balance for a HELOC even with the promotional rates.

Again, this is all speculation on my part, but I'm happy to take advantage of it whatever the reason is.    

[Joshua S.]

Originally posted by @Joshua S.:

Originally posted by @Chris May:

@Joshua S. To be fair, you're at least partially correct. You're not moving $21,000 of future interest liability. I'm using that as a shorthand for "future interest liability on a balance of $10,000". In reality, the $10,000 sitting on your mortgage has a potential  future interest cost of $0 - $21,000, depending on when you pay the principal. The $10,000 sitting on your HELOC has a potential future interest cost of $0 - infinite dollars, depending on when you pay the principal. That's why you shouldn't focus on what that amortization calculator is telling you. It's not giving you an apples-to-apples comparison with the HELOC. 

You really need to look at it on a per-period basis otherwise the comparison doesn't make sense.

Here is 6 months of payments on a 200k mortgage:

Month	Begin	PMT	Interest	Principal	Extra	End
1	200,000.00	(1,073.64)	(833.33)	(240.31)	-	199,759.69
2	199,759.69	(1,073.64)	(832.33)	(241.31)	-	199,518.38
3	199,518.38	(1,073.64)	(831.33)	(242.32)	-	199,276.06
4	199,276.06	(1,073.64)	(830.32)	(243.33)	-	199,032.74
5	199,032.74	(1,073.64)	(829.30)	(244.34)	-	198,788.40
6	198,788.40	(1,073.64)	(828.28)	(245.36)	-	198,543.04

Here's that same mortgage with a 10,000 payment from the HELOC to the mortgage in month one:

Month	Begin	PMT	Interest	Principal	Extra	End
1	200,000.00	(1,073.64)	(833.33)	(240.31)	(10,000.00)	189,759.69
2	189,759.69	(1,073.64)	(790.67)	(282.98)	-	189,476.71
3	189,476.71	(1,073.64)	(789.49)	(284.16)	-	189,192.56
4	189,192.56	(1,073.64)	(788.30)	(285.34)	-	188,907.21
5	188,907.21	(1,073.64)	(787.11)	(286.53)	-	188,620.68
6	188,620.68	(1,073.64)	(785.92)	(287.72)	-	188,332.96

And here is the HELOC interest:

Month	Begin	PMT	Interest	Principal	End
1	10,000.00	-	(41.67)	-	10,000.00
2	10,000.00	-	(41.67)	-	10,000.00
3	10,000.00	-	(41.67)	-	10,000.00
4	10,000.00	-	(41.67)	-	10,000.00
5	10,000.00	-	(41.67)	-	10,000.00
6	10,000.00	-	(41.67)	-	10,000.00

Notice anything about the combined interest payments for each scenario? They're essentially identical. The small difference is really just the timing of the payment within the period. You just shifted ~$42 of interest from the mortgage to the HELOC. If you make a $10,000 payment in month 4 to the HELOC and pay off the balance, it will have the same effect as making a $10,000 mortgage payment of month 4.

But wait! What about the impact of the daily average balance calculation??? Agreed, that is the only "real" source of savings in this scenario. Your example of maybe only having a ADB of $4,000 on that $10,000 is pretty unrealistic, but I'll entertain it. Instead of paying interest on $10,000, you'd pay interest on $4,000, or $16.67. So this elaborate plan saved you r * (ADB - ending balance) = $25 (and, again, bringing down your ADB that much is pretty far fetched, though I'll concede it's possible for high income folks).

Earlier in the thread you said it doesn't even really matter what your interest rate is and you suggested an 8% HELOC. Your interest on that $4,000 ADB would be $26.67 ($15 savings). If your daily average balance was a more realistic $7000, you lost $5! (interest = $46.67)

So yes, you can save a few dollars here and there, but only by gaming the daily average balance formula. The interest rate on the HELOC is very important and the extent to which you game the daily average balance is the only thing actually saving money. 

Ok, thanks, I appreciate you finally giving way to some of my points. And the calculations work out, I can see that it's correct in the mathematical sense and when you add the HELOC interest to the recalculated mortgage interest it adds up to the old interest amount. Great job explaining that, I get that now. But I guess what I'm asking now is how do you reconcile that with the savings we agreed on seeing on the calculators? You just said last time that you see $21,000 savings on the calculator, but I'm just swapping that interest over onto the HELOC and now it's all washing out for some reason because I showed you the $21,000 in HELOC interest wasn't possible. I mean, that's legitimately what just happened, so I don't really understand.

So, apparently the savings are technically at the end when you cut off the mortgage early, what does that look like? Months 340-360 on one table and nothing on the other table, because the mortgage is paid off, right? Or maybe the savings just happen along the way every month? You can try to explain that part if you want, but my point is that it doesn't really matter in the real world how the savings are explained as long as you get them. That's why I was saying that the bottom line is everyone agrees there are a lot of savings in paying extra principal, but when the HELOC is added to the mix it suddenly becomes a magic trick that won't work.

Let's walk slowly through this to make sure I understand. Putting aside the HELOC completely - if I showed up on this thread and said that my wife and I get a total of $10,000 in bonuses every year and we decided to use them to pay extra principal, would you agree that it saves $100,000 and 20 years off of our mortgage?

PS - It seems like we're partly stuck on defining the savings, btw, so I wanted to run something else by you. When I said that extra principal payments allow you to "skip" the corresponding interest altogether everyone scoffed and said you can't skip interest. I'm pretty sure you said it, but Jeremy, Joe, and Steven all definitely said you don't skip interest payments - that the savings come from the fact that there is a lower balance and therefore less interest is charged on the subsequent payments and then over the course of the remaining months the savings add up. I agreed at first, especially since I don't personally care that much you how you define it and the math seemed to work out, but I've realized that it doesn't make sense and is probably part of the reason we are stuck.

As I said initially, the interest payments are "scheduled", but actually accrue daily. They aren't owed automatically the minute you close on the loan. That is factual, everyone knows it, but seems to be repressing it or something. The fact that unequivocally proves that is if you came into a bunch of money and decided to pay off your mortgage tomorrow you would only be paying off the balance, not the balance plus interest. In that scenario, the interest savings COULDN'T POSSIBLY come from savings on subsequent payments, because you don't have any. You literally SKIPPED the interest by paying early. You paid the balance before the interest could accrue, therefore you didn't owe it. I'm sorry you guys are having trouble understanding this, but it's the truth. If you SKIP the remaining interest payments when you are paying off the mortgage early (everyone accepts that), then by paying any portion of the balance early you would also be skipping or "canceling" the corresponding scheduled interest payments for that portion of the balance. In other words, you can't say that in a payoff scenario you skip the rest of the interest payments because you are paying off early and then turn around and say that by paying off $10,000 or $50,000 of the loan early you are somehow saving in a DIFFERENT WAY. It makes no sense. 

If you need more proof, here it is. Imagine you are two years into paying on a $200,000 and June of 2020 your balance is about $192,500. You win the lotto, but instead of millions, you win $170,000. Woo-hoo, let's shorten the mortgage. You plop it on the mortgage and according to Bankrate you save about $126,000 in interest. But you still have about two years to go on your regular payments. 

You guys said that the interest saved on prepaid principal is a function of the amount saved on subsequent payments, not skipping interest payments. But in this scenario, the interest portion dropped by about $600/month after you made that huge payment and you have 24 subsequent payments for a grand total of $14,400 in savings. Obviously, that's nowhere near the $126,000 you are actually saving, which proves that the savings come from actually skipping interest payments altogether. You can't define it any other way. My skipping explanation works all the way through the mortgage and everyone else's subsequent payment explanation does not.

So, when you prepay principal, you literally, actually skip the scheduled interest payments that correspond with that portion of the balance. Which is why when you take $10,000 from your HELOC and put it on your mortgage, you immediately save on interest by canceling those interest payments. This should help you realign your perspective about just moving debt from one spot to another, because you're moving it from a spot where your regular payments are hardly making a dent in it because the interest is getting in the way to a spot where you can annihilate it with every payment.

[Jeremy Z.]

@Joshua S.

"This should help you realign your perspective about just moving debt from one spot to another, because you're moving it from a spot where your regular payments are hardly making a dent in it because the interest is getting in the way to a spot where you can annihilate it with every payment."

This is wrong. It has already been demonstrated to you with examples. The total interest between the remaining mortgage balance and the new HELOC is the same as the interest on just the mortgage before "prepayment". You are paying more each month since you now have a HELOC payment on top of your mortgage payment. That is what is accelerating your mortgage pay down.