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?

[Chris May]

BP needs a downvote option

[Bob L.]

I cannot believe there is so much debate on this topic. The simple answer is that a HELOC CANNOT help you payoff your mortgage faster!

You can see that and proof in a Microsoft Excel worksheet using the PMT formula.  It is all in the math.  There is no magic.  

[Joshua S.]

Originally posted by @Bob L.:

I cannot believe there is so much debate on this topic. The simple answer is that a HELOC CANNOT help you payoff your mortgage faster!

You can see that and proof in a Microsoft Excel worksheet using the PMT formula.  It is all in the math.  There is no magic.  

Hi, Bob. Welcome to the debate. What a thorough analysis. I've come to thinking about it sort of like you're paying your mortgage twice, which helps you to speed the process along. In other words, when most people pay their mortgage they do it once a month and then you move on, but when you use this strategy you aren't just paying your regular payment - you pay the regular payment and then every time you get paid you're putting that against the mortgage, as well. Of course, some of the amount you're putting against the HELOC is temporary, because you may need it again to pay bills, but in the meantime it's keeping your average daily balance down. Money sitting in your checking account doesn't do that, obviously, so you can see there's at least some advantage to this strategy vs traditional banking where you let your money sit around while you wait for bills.

If you decide to come back to talk some more, please answer this question for me if you don't mind. If your mortgage lender offered right now to refinance you with no closing costs to a mortgage that is exactly the same as what you have now except that it also functioned as a line of credit (ie. you could put all of your income into the mortgage, but then still pay your bills when they are due), would you do it? Why or why not?

[Michael Mullins]

A lot of people focus on the HELOC as if it's a magic tool that pays down your mortgage. Really it's the extra income and money from your checking and savings that is setting in the heloc that pays down your debt faster. My wife and I have paid down our primary mortgage and paid off one rental property using this strategy. But it's not going to work for everyone, you have to have a budget and spend less money then you make. It's the extra money you don't spend in your budget that allows you to have more MONEY to pay off the daily amount. We have a three year plan to pay off $150,000 that is left on the house.

Hope this helps.

[Gary Floring]

Originally posted by @Bill F.:

Originally posted by @Joshua S.:

Originally posted by @Chris May:

@Bill F: "You pay $1,140/yr in interest on your HELOC and that in turn saves you $26,000 on your primary mortgage. This is true,...."

So on just that one (out of context) excerpt, you would agree with Joshua on his point that he paid $1,140/yr in HELOC interest to save (or "skip" or "avoid") $26,000 in mortgage interest, right? @Chris May, do you agree with that? (I think that could be a Y or N answer?)
 
"but the savings on the mortgage is over 25-28 years, not one year like the HELOC interest."  

This might be one of the disconnects here. You say Joshua did save/skip/avoid $26,000 in mortgage interest by paying $1,140 in HELOC interest. My understanding is that Joshua says that savings is a one-time, immediate cost avoidance. Are you saying it is not, because it must be spread out over 25-28 years?  [Let's put the $10,000 HELOC (loan) aside for the moment.....]

Sorry to jump in so late but I did read the posts from where I left off a few months ago. 

[Gary Floring]

[FROM A RELATED THREAD]:

@Joshua Smith, "... In the first year of this hypothetical $165,000 / 4.5% loan we've been talking about - when you're whittling away at that first $10,000 - around 74% of your money goes toward interest. When you're paying down the $10,000 on the HELOC about 4-5% of your money is going toward interest...."

And THAT is the major point of the discussion. You can't really compare the HELOC interest RATE to the mortgage interest RATE (APR) because the real key is the AMOUNT of interest paid over time! The point is not how much the mortgage APR is, it is what the ACTUAL interest rate is in the early days of the loan! As you have repeatedly mentioned Joshua, the true "interest rate" in year one is much, much higher than the nominal APR; in this case it is 74%, not 4.5%. Quite a difference! Everyone just skips over this tiny detail, and instead, wants to steer the discussion toward the APR of the mortgage, and then argue about how that compares to the HELOC rate! Instead, the argument should be centered on HOW MANY DOLLARS IN INTEREST IS AVOIDED OVER THE LIFE OF THE MORTGAGE.

The other major point is this. Yes, you could take $10K from your checking account and slam it down on the mortgage to achieve a similar result. HOWEVER,

(a) many people would rather preserve their checking account "cushion" instead of having it applied to the mortgage where it cannot be "retrieved" if needed later. By using HELOC funds instead, or even a zero-percent credit card advance with a 4% transaction fee, they are effectively using the CREDITOR's resources instead of their own money to accelerate mortgage loan payoff (at a "cost" of a few hundred dollars per year). That's another "tiny detail" everyone keeps ignoring. You are using "someone else's money" to accelerate mortgage paydown, not your own. And...

(b), if this method is used year after year, then $10K chunks of money NEVER have to come out of anyone's checking or savings account, because they are effectively using the creditor's funds while repaying them back over the course of a year using this "Velocity Banking" strategy.

(c) It does take major discipline for people to place all of their income into the HELOC or line of credit while ensuring it exceeds their expenses by at least $1,000 per month in order to pay back the $10K within a year. If people cannot budget themselves to do this, the strategy explodes in their face.....

[Brent Coombs]

@Gary Floring, sorry, but you're (also) missing the point! If you borrow $165k, your Lender has fronted you that full amount! So in year one (etc.), your payments are calculated to get the bank back exactly their 4.5% interest (plus a 30th of the principal if it's over 30 years). 

If you want to pay off a mortgage quicker, you already have the options of A: Borrowing less than you can afford to pay back in the first place, but paying it off as if you borrowed more, or B: Setting it up so you're required to pay it off quicker in the first place! Now do you get the point? Cheers... 

[Jeremy Z.]

@Gary Floring

As you have repeatedly mentioned Joshua, the true "interest rate" in year one is much, much higher than the nominal APR; in this case it is 74%, not 4.5%.

This statement is absolutely false. The interest rate in year one is not 74%. If you want to argue that a HELOC is a good tool for managing the process of making extra payments toward principle that is fine, but stop spreading misinformation in the process.

[Gary Floring]

Then educate me, please. On a 30 year, $165,000 mortgage loan with an APR of 4.5%, what is RATIO of interest-to-principal paid in the first year of the loan?

[Wayne Brooks]

@Gary Floring I’m going to assume you are not really that totally ignorant about figuring out interest charges, but rather you’re just drunk on the VB koolaid, or part of Renatus yourself.....

The “ratio” of interest to principal payments is Purely a function of how much principal is outstanding on the loan, whether it be a 30year mtg or a heloc.  This is easily determined by looking at the interest charge for any given month in amortization schedule.

The reason you only pay “4-5% of all payments in interest” on your heloc that you paid off in a year is Because you paid the Whole Principal balance off.....this “ratio” nonsense is just more smoke and mirrors.

To be clear, the monthly interest charges on a 30year mtg are calculated Exacyly the same as for a heloc.  Example:

$100k mtg, 6%, 30years....interest due end of month 1...........$500

$100k Heloc, 6%.................interest due end of month 1           $500

With a $10k heloc payment to mtg, no money out of pocket to pay down heloc balance:

Same 30year mtg 6%, balance now $90k...........interest due at end of month $450

Heloc. $10k balance, 6%.......................................interest due at end of month  $ 50

                                   TOTAL INTEREST DUE THAT MONTH.....Wait For It............$500

Assuming you have the Same interest rate for both the mtg and the heloc, simply transferring the balance does Nothing At All.  No gain occurs Until you pay Extra Money above your regular mtg payment, Either to the heloc, or directly to the mtg.  This whole “chunking” as you guys like to call it, obviously means nothing.

There is no magic to the heloc.....the Only advantage to the heloc is if you are not sure you can afford the extra $500/mo payments, without getting in a bind.  If that’s the case, then simply open up a heloc, Don’t use it unless you get in a bind, and throw the extra $500/mo to your mtg.

[Gary Floring]

@Wayne Brooks 

The question was,

On a 30 year, $165,000 mortgage loan with an APR of 4.5%, what is RATIO of interest-to-principal paid in the first year of the loan...

???

[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?

[Storm S.]

I’m a math major and I’m not seeing how this is saving any money pay off early my cheaper debt with more expensive debt. Also a comment about using a heloc as a savings account. You pay interest to use it as a savings or as an alternative I could put my money in a discover savings account and get paid 2% interest compounding daily. Where I could if I wanted to pay down the original mortgage with that extra interest actually lowering my debt faster

[Justin Bauer]

I have been using a helock for the last 10 years and what I have learned is money works all of the time.The question is is it working for you or the bank.Do you think a bank does not use your daily deposit's to make loans?The problem is paying off a mortgage early.Once you send that  extra principal payment it is gone forever out of your control.Ask some investors that lost property's back in the melt down if they wish they would of payed more principal back. We have never had such cheap money and you want to give it back?

There are company's out there making millions by teaching this strategy to the general public and I think its great but it is something we all should have been taught in grade school.I am not a math major but you either control money or some one else will.

[Wayne Brooks]

Originally posted by @Gary Floring:

@Wayne Brooks 

The question was,

On a 30 year, $165,000 mortgage loan with an APR of 4.5%, what is RATIO of interest-to-principal paid in the first year of the loan...

???

It’s an irrelevant, and ignorant, point.....but, it is The Same Exact ratio it would be if you had a $165k Heloc and made the same payments......the interest due each month on $165k is of course a lot more than the interest due on $10k....so, if you made the same, say $500/mo principal payments, on each then of course you pay more interest on $165k than you do $10k.

You can’t really be that blind....I guess the Renatus sales pitch is predicated on the listener ignoring reality.

[Nick Moriwaki]

@Storm S.

The method I described saves you the interest of the mortgage per day since you no longer pay that interest whenever that money is sitting in your HELOC.

So for example if my principal were $200K @3% and I had $50K in my savings account earning 2%. I'd rather have a HELOC balance of $150K @3% and $0 in my 2% savings account. Essentially I'm "earning" 1% a day on the $50K by putting it into the HELOC rather than in the savings.

[Brent Coombs]

Originally posted by @Gary Floring:

@Wayne Brooks 

The question was,

On a 30 year, $165,000 mortgage loan with an APR of 4.5%, what is RATIO of interest-to-principal paid in the first year of the loan...

???

Gary, Wayne summed up your question well: "Irrelevant". "Ignorant". Let's take another scenario, to show you why your "Ratio" question is the wrong question! eg. Someone takes out an Interest-only loan, which means your "Ratio" would be fully 100% interest-to-principal. But I say: so what?

ie. Each year, they're only required to pay 4.5% of the total principal borrowed! But you might ask: Why would any borrower be idiotic enough to agree to such an arrangement?

Simple: That same borrower knows ways to earn much better than 4.5% interest each year with all that money they've been loaned (including the appreciation of their well-bought primary)! 

[Many folk have mortgages that charge even less than 4.5% annual interest, yet posts like yours still suggest paying it off early (via a HELOC) is the best use of extra income?]

eg. If I had borrowed $200k 30 years ago to buy a nice primary in the bay area, do you think I'd mind if I still owed $200k on it (now that it's worth 2 Million)?...

[Chris May]

Originally posted by @Storm S.:

I’m a math major and I’m not seeing how this is saving any money pay off early my cheaper debt with more expensive debt. Also a comment about using a heloc as a savings account. You pay interest to use it as a savings or as an alternative I could put my money in a discover savings account and get paid 2% interest compounding daily. Where I could if I wanted to pay down the original mortgage with that extra interest actually lowering my debt faster

Spot on. It doesn't save money. I worked in accounting policy for years--if this were true, no company would ever hold amortized debt. But, of course anyone working in Finance knows that amortization isn't an interest calculation methodology... it's a PAYMENT payment. 

[Jeremy Z.]

@Nick Moriwaki

I have always appreciated that you understand the math involved in these back-and-forth discussions, and are willing to work through the numbers. I agree with your example, that $50,000 used to offset a HELOC at 3% will net more savings than a savings account earning 2%. However, I think your scenario is rather unique, and not the same situation laid out by 95% of the people who advocate for this method.

To be clear, I don't have an issue with people paying a chunk of their mortgage with a HELOC and rapidly paying it down if they feel that suits them better than just paying down their mortgage. Whether they should pay their mortgage down early is a separate debate, and I acknowledge that there are people who might want to eliminate debt more aggressively. I myself have a 15-year mortgage because the interest rate was substantially better than the 30-year option at the time.

My only real issue is with the bogus "mortgages are font-loaded" claim that @Gary Floring, Joshua Smith, and others have made on this thread.

In the example Gary uses above, he compares the total interest in year one of a $165,000 mortgage and a $10,000 HELOC. The problem is, he completely ignores the interest he is still simultaneously paying on the remaining $155,000 mortgage balance! It's insanity! Madness I tell you!

A mortgage isn't a trick like these other HELOC Hucksters will have people believe. That's the primary thing I'm here to police.

Cheers!

[Nick Moriwaki]

@Jeremy Z.

Completely with you. The example is unique compared to everything else I've seen posted on here. But that's the reason I keep chiming in - it shouldn't be. I've always used that method, but I used to be one of those people who thought the chunking strategy also worked, just with a little more complicated math. That is until I started going back and forth on these forums and realized that interest isn't front loaded in a mortgage any more so than it is in a HELOC. That's what made me realize the mortgage to HELOC conversion is the only HELOC strategy that actually works and I've been trying to pitch it to people on both sides of the argument.  Unfortunately I feel like I keep getting brushed aside since "that's not what all the pro-HELOC people are saying".  

As a side question - are you saying the scenario is unique because no one uses it or that it isn't feasible to employ?  That's what I've always wanted to get to the bottom of.  I feel like most people think it's a fairy tale scenario that works but can't reasonably be applied to most people when in reality I think it's very applicable to almost everyone here.  

[Justin H.]

@Nick Moriwaki It works for you because you have access to HELOC's with promotional interest rates less than the mortgage rates. From what I have seen, this is not true for the (vast) majority of people reading your comments. I have done the math, and assuming someone works equally diligently towards whatever method they choose, the simple answer is to put as much debt as possible into whichever has the lower interest rate.

[Justin H.]

@Gary Floring 

Lets say you took out a $100k mortgage @5%, with a monthly payment of 536.82. You pay down $5k on it with a LOC @5.5%, using the 'velocity'/HELOC method, and in order to pay that LOC back within 1 year you'll have an additional monthly payment of 429.18. That means you're actually paying 966.00 per month in total. Since you can afford to pay 966.00 per month, and we're talking about 'velocity' here, let's maximize this by continuing to do so every year until payoff. At this rate the mortgage itself will be paid off in Jan 2030 with 33,549.03 interest having been paid. However that last payment was a 1,771.69 LOC lump, so paying off the last of the LOC at 966.00 per month takes an extra 2 months and costs 11.85 in interest. Additionally, you paid 150.21 in interest on each previous $5k LOC draw, totaling up to 1,652.31 over the 11 full years. Add these all together and the payoff took 134 months and at a cost of 35,201.31 in total interest paid on all debts.

Lets also say I took out a $100k mortgage @5%, with a monthly payment of 536.82, but I simply pay that same additional 429.18 on it per month. My mortgage will be paid off in May 2029 (124 months) with 31,136.78 in total interest paid. I will have paid off all debts 10 months sooner and at a savings of 4,064.56 over your method.

Now admittedly, I have not (yet) accounted for the lower average daily balance on your LOC...So let's look at that. Thanks to the modest 0.5% higher interest rate on your LOC, in order to keep up with my conventional over-payment method you will need a savings in interest of 32.78 per month on said LOC due to the reduced average daily balance. In order to achieve that savings from the LOC interest, you would need to maintain an average daily balance 7,151.72 lower than me...And if being equally diligent on both methods, it is not possible for the average daily balance savings from the LOC to be greater than the total value of the LOC itself.

In other words, while yes this accelerates your payback vs doing nothing, any higher interest rate on the LOC more than offsets the average daily balance savings. So despite the hype, the savings actually accumulate more slowly in the real world than other more conventional accelerated payment methods.

[Nick Moriwaki]

Originally posted by @Justin H.:

@Nick Moriwaki It works for you because you have access to HELOC's with promotional interest rates less than the mortgage rates. From what I have seen, this is not true for the (vast) majority of people reading your comments. I have done the math, and assuming someone works equally diligently towards whatever method they choose, the simple answer is to put as much debt as possible into whichever has the lower interest rate.

It is true that in Hawaii we get access to promotional rates, but my examples don't use promotional rates to prove what I am saying. If you read my post I said that if you convert the mortgage to a HELOC (i.e. - replace the mortgage balance with a HELOC balance), you are able to put 100% of your money towards the principal and at no point is money sitting idle (or earning less interest) in a checking/savings account. Are you arguing that it is possible to match these payments while keeping a traditional mortgage? If not, then the method will quickly accelerate past any pay down strategy that keeps the mortgage.

[Jeremy Z.]

@Nick Moriwaki

As a side question - are you saying the scenario is unique because no one uses it or that it isn't feasible to employ?

I'm saying it probably isn't feasible for most readers for several possible reasons:

• Not enough existing funds on hand to make it worth while
• Lack of access to the HELOC products you mention (wasn't it already determined that Hawaii has some unique products?)
• They have better ways to use the money (you can ignore this for the sake of example, but it needs to be factored in when considering the benefits)
• They prefer the safety of a fixed mortgage compared to a HELOC

I'm glad to hear this thread helped clear up some misconceptions you had about mortgage interest.

[Justin H.]

@Nick Moriwaki I'll grant you that doing it your very specific way would maintain some advantage up to a slightly higher interest rate on a first position HELOC as compared to a conventional mortgage...But as the interest rates diverge between the two, as they most commonly do for the rest of us schmucks, every time I run any type of math on any of these scenarios it keeps going back to showing that the rates still quickly become the dominant factor.