How to Use a HELOC to Pay for Your House

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Using a little understood technique of moving your money to its most advantageous position, you could cut 10 or even 20 years off your 30-year fixed home mortgage.

The concept is simple: move money worth x dollars over to a place where it’s worth y dollars, for example trading U.S. dollars for Euros–or whatever the money markets of the day show could be profitable. The difference doesn’t have to be very much. A gain of ½ a cent could yield a profit of $5000 overnight if $1,000,000 were placed in such a position. Stock markets work on a similar principle: invest a dollar today for something anticipated to be worth more than a dollar in the future.

Bringing it closer home, you can achieve results similar to these investment gains by moving your home’s equity to something that is costing you more than your house. The main difference is instead of spending a dollar to earn a profit of 15¢, you’ll spend 15¢ to avoid being charged the whole dollar.*

“What is costing me more than my house?” The simple answer is “the mortgage interest you pay on your house.”** Therefore, anything you can do to cut the mortgage interest charged you is a quick way to save money.

Now back to the notion of moving money from one place to another to realize a gain. Instead of x and y—which makes the eyes of everyone who did poorly in algebra glaze over, including my own, let’s call them cookies and ice cream. Your mortgage debt will be ice cream. We’ll get to the cookies in a minute. Right now, since the mortgage interest on your home could be your largest expense, we’ll call that a stomach ache. Stepping back to look at something not quite that costly which we might parlay into a savings at ice cream brings us back to the home itself, cookies.

You convert some of your cookies, specifically home equity, to ice cream, your home loan. The amount you transfer will reduce your stomach ache (mortgage interest) exponentially. In other words, the more cookies (equity) you use to reduce the ice cream (principal of the mortgage), the more stomach ache (proportion of interest) you will avoid.

To illustrate, to borrow $200,000 for 30 years at 6% will ultimately cost you $231,676.38 in interest payments alone. That's a mighty big stomach ache! Transferring $5000 from your accumulated equity six months into your loan (assuming your home has increased in value), erases $22,651.35 from that projected interest. That’s exponential savings. Five thousand dollars of cookies cut nearly $23,000 from your stomach ache, a 453% return. Though it will take 28.1 years to fully appreciate your accomplishment, comparing it to any other kind of investment, this is a 16.1211% annualized return.

HELOC-definition.jpgIn order to draw $5000 of cookies out of your home’s equity, you’ll need a to get from a bank a home equity line of credit (HELOC)–far preferable to a home equity loan (HEL) for generating cash savings. Of course, the $5000 must be repaid. If you were unaware of ways to reduce interest on a HELOC, and paid it back over a year’s time at 8.25%, it would cost you $430. So in this worst of all cases scenario, the $22,651 you cut off your stomach ache cost you $430. That’s more than a 5000% increase in value, a 184% annualized return. 

Some people object to debt and will not use this technique because it calls for a HELOC. In the example, the $5000 draw on home equity reduced the $200,000 of mortgage principal owed on the primary residence. By changing $5000 from mortgage debt into HELOC debt, we now have $195,000 in ice cream and $5000 in cookies. The same amount of sweets as before, just in a different form. In other words, we restructured a miniscule part of the home loan. We didn’t borrow more money. But we did cut the stomach ache by nearly $23,000. 

Employing this technique not just once, but once a year, cuts $119,480 off projected mortgage interest paybacks—that’s a lot of stomach ache avoided. To put it in perspective, your home would be paid for in half the time, and you could pay someone’s way through college, or feed and clothe 30 starving children for 10 years.

For a complete guide to using your home to pay for your home, get the Let Your Mortgage Make You Rich kit, consisting of a 96-page workbook and several companion ebooks on fixing your credit, real estate, and becoming wealthy.

 _________
*these numbers are used to create a metaphor; they are not intended to illustrate actual expenditures or savings

 ** mortgage interest on a 30-year fixed home loan is nearly equal to the principal borrow when the interest rate is about 5.31% per year.

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55 Comments on How to Use a HELOC to Pay for Your House »

November 28, 2007

Money Merge Account Not a Scam | The Great Mortgage Revolt @ 9:03 am (Pingback)

[…] the principal on a mortgage, a technique that migrated to the U.S. from Australia in the 80s. Several books have been written on the […]

December 29, 2007

Pay Off Your Home Years Sooner | The Great Mortgage Revolt @ 11:06 am (Pingback)

[…] what if you don't have an extra $500 a month? That's where using the equity in your home (the paid-for portion, or increased value if properties have gone up in your area)  comes in […]

January 17, 2008

Best Way to Pay off a Mortgage | The Great Mortgage Revolt @ 11:15 am (Pingback)

[…] The other thing you can do right now is read a little article about using your house to pay for your house. […]

[…] one of the many alternative programs available for under $100. Read more about the basic premise of using a home equity line of credit (HELOC) to pay off your home years […]

[…] advice? Pay off your home as soon as you can. Use your house to pay for your house, […]

July 6, 2008

Heloc @ 2:57 am:

What about the HELOC payment? You borrowed $5000 at the beginning of each year, if you pay it off over the course of the year, you have to pay an additional $435/month, or the HELOC balance would be $5430 at the end of the year. You do save $119,480 off of the interest on the mortgage, but you're doing so by paying extra principal. If you just paid the $435 HELOC payment as extra principal each month, you would save $121,587 in interest over the life of the mortgage. Why bother borrowing it and paying it back?

The Great Mortgage Revolt @ 7:26 am:

Hello Heloc - thanks for opening a discussion. I cannot comment on the numbers you proposed, because they are incomplete for making calculations. Missing info: term of loan, interest rate, interest rate on HELOC, family's discretionary income (or even net income).

However, there are some general principles on which I can comment.

1) The HELOC should be repaid painlessly by holding all the income until it's needed for bills. Therefore, interest accruing on the HELOC should amount to about 1/2 the going rate.

2) If it takes a family 12 months to repay a $5000 HELOC, they should be using a smaller amount. You are assuming that after mortgage, utilities, groceries, gas, tuition–all regular expenses including property takes, auto insurance, etc, the family HAS only $5000 that could be used part-time or full-time to replenish the HELOC. If money is that tight with them, they should be playing the game with a smaller amount.

3) If they use the technique in the next to the last chapter of the manual, they never write a check or have an automatic withdrawal of a monthly HELOC payment.

4) Taking money from a HELOC to apply to your mortgage principal is not "borrowing money." It is "moving money." Specifically, it is exchanging an expensive type of debt (mortgage) for an inexpensive type (HELOC).

5) The financial principle involved is the "velocity of money" It will always be more advantageous to apply a larger lump sum to a loan at the beginning of any period than to divide the lump sum and apply it in 12 (or even two) smaller amounts. It would be worthwhile to be able to check your numbers, because they seem to work counter to "velocity."

You are missing critical information on how the system in the article above works. If you are sincere, buy the book — or someone else's book.

Does this make sense?

September 22, 2008

Rich Wright @ 12:39 pm:

If one has adequate equity for a HELOC to pay off the entire balance of the conventional mortgage, would this not be the ideal thing to do? EX: $100,000.00 HELOC with an $80,000.00 balance on a mortgage with rates of 5% and 5.75% respectivly. The HELOC intrest is also deductable is it not? (both on same, primary property)

October 3, 2008

Doug @ 5:58 pm:

@Heloc and Rich Wright, think about what your mtg statements could look like after the first year (I'm ball-parking it here so, really, look at your amortization to see what I'm talking about in detail). In my case, my mtg payments in the first year lower my PRINCIPAL around about $1000. Now, if I were to have paid that $1000 up front, that would have knocked a year off of my schedule just in real dollars. So paying that $1000 up front already puts me about one year ahead of schedule - of course, I realize that another $1000 payment will not knock the same amount of time off the schedule since the principal payments the next year will equal more than around about $1000, which is true the next year and the next. HOWEVER, that extra $1000 DOES still knocks SOME time off - more than just a month but less than a full year.

So, you ask, how does the HELOC come into play? In an EFFECTIVE way? Well, you take a comfortable amount from your HELOC to pay down a chunk of your mtg. Then, when your paycheck comes in, you could put all or some of it into your HELOC to pay it down too, reducing the interest (and amount owed) by the amount of your paycheck.

Now I'm thinking you're asking, "what about the bills that are due right after I get my paycheck?" Well, pull some money out of your HELOC to pay those bills. Then when your next paycheck comes, again, put all of it or some of it into your HELOC again. That may pay it down completely, but you may still have some bills coming up so, draw from the HELOC some more to pay those bills too.

Now at the end of the month, hopefully your HELOC is close to being paid off with a balance close to $0 outstanding. At this point you can start all over again by sending your regular mtg payment plus an extra $1000 to apply to the principal again. All of which will come from your HELOC because, as I said at the beginning of this paragraph, your HELOC is $0 which implies that your checking/savings account balance is near $0 too.

But that is OK because you will be paid in a couple of weeks and that paycheck will all go into your HELOC balance again, then bills will need to be paid increasing the HELOC a little, then another paycheck and some more bills.

At this point, your next mtg payment will be due. If your HELOC is still in the red maybe you will only feel comfortable paying just the minimum mtg payment so that you can get your HELOC balance back down to $0 this month.

Or, maybe your are comfortable sending a bigger chunk from your HELOC, say $2000 or $3000, to pay down your mtg and then spend a couple of months only sending the minimum payment for your mtg while your paychecks pay down your HELOC to $0.

Then start all over again.

This begs the question of what about an emergency or a desired vacation that might equal a few thousand dollars, or even a layoff? Well, that gets to the question of how much your HELOC should be and how deep you dip into it each month. Someone brought up the question of taking $5000 from the HELOC to send to the mtg company. If one does so, one should also have a buffer ABOVE that amount REMAINING in the HELOC to draw upon.

This gets to YOUR specific situation. If you can only get a HELOC that is $5000 then by no means should you send all of it and all of your savings and checking account to your mortgage company. If you did so, and if you had an emergency you would then, theoretically, have to borrow money from other sources to handle that emergency. The idea is not to get in over your head - only work with small amounts for starters and back off if you see the HELOC balance owed getting too high and/or uncomfortable for you. If you first started by sending $1000 and realized you are going deeper into debt as the months go buy, drop down to $500 or $200 principal payments instead. Play with it until you are comfortable.

By the same token, if your bank (or better, credit union) gives you a whopping $30,000 HELOC ask yourself if you really should send in even half of that because how long would it take YOU to pay off that $15,000 balance to $0? If your take-home pay is $6000 every 2 weeks, maybe not long. If your take-home pay is $1200, then you should consider NOT using most of your HELOC but only send in some 1, 2, or $5000 at a time. Then if you have an emergency you still have well over $20,000 in your HELOC if you truly need it - and of course lets pray you wouldn't need it.

So anyway, that's my 2-cents worth.

January 6, 2009

Peter M Vaughan @ 1:52 pm:

You take money out of the HELOC and put it into the mortgage, so that there is less principle due on the primary and it accrues less interest. But you borrow on the HELOC, and so the HELOC accrues interest. In the example given above, the $5000 HELOC is assumed paid off in a year with $430 of interest.That means that in addition to paying your mortgage, you paid an additional $5430, $5000 of which went to the principle and $430 to interest.

If you repeated this process, paying $5000 a year onto the principle as a lump sum out of a HELOC and $430 in interest to the HELOC, the $200,000 mortgage would be paid off in 16 years and 6 months.

Instead, taking $452.50 a month (which is what it takes to pay off the HELOC over the course of the year) and paying it directly to the principle of the mortgage without ever bothering with a HELOC your mortgage would be paid off in 15 years and 7 months.

Unless the HELOC is at a lower rate, paying extra mortgage payments is the way to go.

An argument can be made that paying bills from a HELOC so a tax deduction on the interest can be claimed is also sort of absurd. If bills total $5000, interest comes to $430, and at a 25% tax bracket you get $107 off your tax bill after paying the bank $430.

Pay your bills with money, pay your mortgage with money. Then when the mortgage is paid off and you're not paying anyone any interest, keep it that way.

February 6, 2009

Greg @ 3:34 am:

Peter,

Sometimes it can be cheaper using a HELOC even if the interest rate is much higher that the interest rate on the mortgage. I have an example of comparing the HELOC technique against extra principle payments at: http://www.mydebteliminationcalculator.com/gpage16.html. There are a few factors that go into making it beat simple extra principal payments: frequency of expenses and frequency of income being received. And I am definitely not trying to say that it always beats extra principal payments. But don't write it off completely without a little more analysis.

February 9, 2009

Peter M Vaughan @ 5:03 am:

Greg,
The example given in your link shows that it can save you some money to pay your mortgage off by submitting payments twice a month, not that using a HELOC results in a faster payoff. Because interest compounds daily, it is true that making payments twice a month instead of once a month will save a small amount of interest. However, comparing using a HELOC which is paid twice a month to a mortgage payment made monthly is not a valid way to compare the two methods to determine which most effectively pays off ones home.
There is no way to temporarily borrow money at a higher interest rate to pay off money at a lower interest rate and come out ahead in a valid comparison of the two systems.
However, I wish you the best of luck in selling your computer program.

Greg @ 6:24 am:

Peter,
The comparisons in my page make one mortgage payment each month. The comparisons are made against two different methods to get the extra principal for the payment. One method uses a HELOC as the source; one method uses what is left over at the end of month. There is not one example that makes multiple mortgage payments - the HELOC methods pay down the HELOC balance twice a month but that is not the same as a mortgage payment and is the point of the system. The criteria used for evaluating which method is better is this: which method costs the least amount to pay off the debt. In all my examples the "HELOC shuffle" method pays off the debt in the same amount of time but with less total interest paid - and that's with an over inflated HELOC interest rate.

So your statement "There is no way to temporarily borrow money at a higher interest rate to pay off money at a lower interest rate and come out ahead in a valid comparison of the two systems" is just flat out ignoring the facts presented - facts that are backed-up with the actual computations so that you can verify them yourself.

Now, the examples on my page were manufactured for the comparison - I needed to setup a situation that I could use my software to easily compare both payment methods. That meant I had to setup the mortgage payment at a weird time of the month so that the HELOC would be ignored for the extra payment in the "regular" method. But outside of that, I would argue that they resemble a reasonable model of someone's potential finances.

But the results are clear, the HELOC method _can_ be cheaper. (Is it always? absolutely not.) And it doesn't even take a HELOC interest rate cheaper that the interest rate on the debt to achieve.

Peter M Vaughan @ 7:03 am:

Greg,
Perhaps I misspoke in my earlier comment. To aviod confusion, making a debt payment - whether it is on a HELOC or a traditional mortgage - twice a month when daily compounding occurs will definately save some money. But making that debt payment directly to the mortgage company (paying your mortgage semi-monthly for half the 30 year payment and half the extra payment) will result in a greater savings than using a HELOC shuffle because you are borrowing money at a lower interest rate and paying it back at the same rate (two debt payments per month).
I stand by my assertion that it is not possible to borrow money at a higher interest rate, make repayment on the same schedule and come out ahead. Making payments on debts with a different payment schedule is still not a valid comparison of the two debt repayment methods.
Of course, if you already have a monthly mortgage and your mortgage company will not accept semi-monthly payments, that is a different issue entirely and utilizing a HELOC shuffle to get around the problem you have already created for yourself may make sense in that case.

Doug @ 9:42 am:

Peter, let me first state that I'm not selling anything here and won't be selling anything here.

The point is that by using a HELOC you can pay the MAX amount possible each month to your mortgage company to reduce your mortgage by a larger-than-normal percentage, while at the same time your paycheck is plowed back into the HELOC every 2 weeks or 1 week or 1 month depending on how frequently you get paid. THAT is where the power of this methodology works. Say you win $100 playing poker one night - THAT money can go directly into your HELOC the next day, assuming you deposit it and transfer that money to your HELOC.

But you won't be able to plow every dime of your paycheck - or every $20 you find in a sport coat you haven't worn in 2 years - into your mortgage w/out having to borrow money from somewhere else to pay your upcoming bills. By borrowing against your HELOC (for short periods, say, 1 month at a time, then pay it off) you are able to dramatically reduce your mortgage and at the same time you can borrow against your HELOC to pay your monthly bills. But then you can reduce your HELOC as the month progresses when you get paid. You can't borrow against your mortgage.

And, depending on the current interest rates, the interest (in real dollars) you pay on your HELOC can be less than what you would have paid on that amount of money for the month had it remained in your mortgage. In other words, you would be paying interest on that money (say it was $1,500 for that month) but you would pay the WHOLE month's worth of interest on the FULL $1,500 by leaving it in the mortgage balance. Whereas, pulling that $1,500 out of your HELOC to pay down your mortgage means you pay the FULL interest on that $1,500 for a few days (maybe 2 weeks?) until your paycheck arrives. When it does you then pay down your HELOC with your paycheck, at which point your are paying interest on PART of the original $1,500 your borrowed until your next paycheck arrives (thereby DECREASING the remaining balance of your borrowed HELOC money even further) or until your next bill comes due (thereby INCREASING the remaining balance of your borrowed HELOC money a little).

The end result is that your HELOC balance due will increase and decrease rather dramatically during the month, while your mortgage balance due simply decreases dramatically. This means that for that month, you no longer pay interest to your MORTGAGE company for that balance (say, the $1,500 I mentioned above) and for that month, you only pay interest on the part of the $1,500 you still have to pay down in your HELOC throughout the month. In other words, the goal is to decrease the AVERAGE daily balance of the HELOC throughout the month such that it ends up at or near $0 due in in your HELOC at the end of the month. So maybe you pay the potentially higher HELOC interest rate (although right now my HELOC rate is LOWER than my mortgage rate) but only on say $900, on average, through the month as your paychecks come in and as bills come due.

Also, the next month you send in your mortgage payment your principle will decrease THAT much more because you have been paying down your mortgage dramatically.

We are not saying that you get a $50,000 HELOC and borrow the FULL $50,000 to pay down your mortgage then spend the next 2 or 3 years trying to pay down the large HELOC balance due, which likely WILL have a higher interest rate, as you pointed out. This method suggests pulling out an amount from the HELOC which will allow you to draw down your mortgage balance, but which you can pay back in a short period of time (preferably a month). Then repeat every month there after.

The power is being able to use EVERY DIME in your checking or savings account to whack down your mortgage balance and increase principle.

But, discipline is key with this strategy and timing too, in this economy it can be more risky to NOT save money for a potential layoff any day now. But, in a more stable economy (or with a secure job) one can use this strategy to put every dollar to use. The key is to NOT use your entire HELOC balance to pay down the mortgage. Use only enough that you will be able to repay in a month or two then start the process over. This is SIMILAR to the strategy you propose, Peter, but it is better because you can put MORE of your money to work paying down your mortgage balance while at the same time you still have a cushion (which is the the available HELOC balance that you DON'T send to your mortgage company) that allows you to pay bills and the occasional emergency expense.

Let me repeat: it is similar to the method you mention, Peter, but the difference is that this strategy is more aggressive in that it allows you to put more money into paying down your mortgage just that much faster. Your way is good but this is even more aggressive. And having said that, I can concede that your way is safer, depending on one's finances, whereas this method is somewhat riskier - especially in this economy.

Doug @ 9:50 am:

Ooops, I said, "The power is being able to use EVERY DIME in your checking or savings account to whack down your mortgage balance and increase principle." I meant, "… increase equity in your home," or "… decrease principle."

Peter M Vaughan @ 9:59 am:

Doug,
My point was simply that if you pay your bills out of your paycheck, and then apply all of the extra cash to the mortgage, you come out ahead. This is true because you have a lower interest rate on your mortgage than your HELOC. If you sent your $100 of poker winnings to your mortgage company, they would reduce your principle by $100 when they received payment, and interest would stop on that $100. Similarly for all your other money. The FASTEST way to pay off your mortgage is to pay it off all by itself without a HELOC, and to apply all extra money you have to the mortgage at the earliest possible date.
The whole crux of the HELOC shuffle method is that payment can be made immediately and a few days of interest can be save, which over the course of 30 years will add up. My point is that if you have a borrowers right to repayment which allows you to pay down principle when you submit the payment, this is the best method. Of course, if you don't have this option, then the days of interest will add up until the mortgage payment is credited.

March 16, 2009

Dennis @ 6:22 pm:

Gents,

I feel compelled to throw in my two cents for what they're worth on this. I also am not selling anything but am always interested in finding ways to cut debt and wrest a bit of initiative from the banks. I just stumbled across this concept myself last week and have been feverishly working the numbers ever since. It's pretty eye opening how much we could save on interest. And all we'd be doing is banking through our HELOC. What resonates the most with me is the bank's use of the daily balance on a mortgage. Our mortgages accrue interest every single day of the month, yet we only pay it once a month. That means that every day the bank heaps another chunk of interest to our loans, but only collects a payment once a month. Meanwhile, the bank uses our deposited savings and checking to lend to others (at a much higher interest rate than what they pay us) until we draw it out. By converting some of a mortgage loan to a HELOC (even one with higher interest) AND depositing our wages into it, we can decrease the daily balance pretty significantly, even if it's only for a short period of time, before we need to draw the money to pay our normal bills. We can add more fuel to the fire by stashing our savings in there as well. By doing this, we manipulate our own daily balance, pushing it down to benefit us. We simply do our banking through our HELOCs, using them as temporary stopping/holding points for our $$. Every day that our money sits in there is reducing the daily balance and thus our interest. Makes a lot of sense and I can't seem to find any holes in the logic. Anyone else? If so, I'd like to hear your thoughts since I'm getting ready to pull the trigger on this. Thanks a bunch for your attention.

Dennis

December 5, 2010

qwest @ 12:31 pm:

Is it beneficial to take a HELOC to pay of mortgage completely?- In this case the the only remaining loan you'll have is the HELOC.
For example HELOC for $150K to pay of mortgage on $150K if the home equity is above $250K.

Peter M Vaughan @ 1:56 pm:

Qwest,
Taking out a $150k HELOC to pay off a $150K first would be a horrible idea. Talk to your bank about it and they'll explain why.

January 3, 2011

Theresa @ 10:08 am:

Qwest…that is EXACTLY what you should do, as long as you have the equity in your home to do it…My husband and I did exactly that about a year and half ago and are thrilled with how the HELOC works. With our conventional mortgage, in a 12 month period, we had only reduced our principal by $4800. After hearing about this process with the HELOC, we transferred our entire mortgage over to the HELOC…within 12 months, we had taken $22000 off of our prinicpal…we have a 10 year HELOC that will be paid off in 4 years.

No disrespect Peter…but this works and works really well, if you do it right. If you are a spender…don't do it.. too much money is available to you as the HELOC gets paid down. In essence, your house becomes your savings account. The banks that tell you it won't work are the ones that either don't understand it or don't want to lose the interest they can make off of us.

We are VERY happy with how this worked so beautifully…our goal is to pay this down and sell…even in a terrible market, we can now take a "loss" on our home and still walk away with money in our pocket for a nicer house in the near future and do this all over again….

Key bank has a fantastic HELOC program that works great for this…and they understand how this works. We were told that we were one of the few doing it right.

August 18, 2011

Remi @ 3:24 am:

Peter, Qwest,

(1) Outstanding first mortgage of $50,000 at 6%
(2) Equity in the house of $150,000
(3) Get a HELOC of $50,000 at 4%
(4) Pay off first mortgage with HELOC money
(5) I am now left with a $50,000 HELOC at 4%

It seems that both loans could be paid off in a similar manner. The interest on both is also deductable. Asking Peter: What would the bank say is so horrible about chosing (5)?

Peter M Vaughan @ 5:32 am:

Remi,
The bank will not give you a fixed rate HELOC at a lower rate than a fixed rate first mortgage. That's what they will tell you. Search on bankrate. For a 50k loan with a lot of equity, you can get a 30 yr mortgage at 4% or a HELOC for 4.5%.

Remi @ 9:02 am:

Thank you Peter. So now the argument is that through judiciously taking out and putting back money (from paychecks etc.) in your HELOC that you could effectively lower the interest rate of 4.5% of your HELO to maybe 2%. I can see that by using your HELOC as a sort of checking account where you deposit your income that you may not have to pay the full 4.5%. Is there anything wrong with this reasoning? :) I appreciate your comments Peter.

Peter M Vaughan @ 8:11 pm:

Remi,
I am not aware of any schedule of payments that can shave 2.5% off of an effective interest rate of 4%. If you can come up with some time line of deposits where your HELOC interest rate would in fact by effectively 2%, I would be interested to see what it is. If you can, please make up an excel spreadsheet with a starting balance of 50k, the proposed payment schedule, and the effective interest rate and post it online somewhere. This would be extremely valuable information. I am not aware of any payment scheme which will shave 2.5% off a 4.5% rate. I am not even aware of any payment scheme that would reduce the rate below the 4% you could get on a fixed rate with monthly payments. I'm interested to see what you can come up with.

August 19, 2011

Remi @ 3:31 am:

Scenario:
(1) Outstanding first mortgage of $50,000 at 6%
(2) Equity in the house of $150,000
(3) Get a HELOC of $50,000 at 4%
(4) Pay off first mortgage with HELOC money
(5) I am now left with a $50,000 HELOC at 4%

As you said, if you can't get a HELOC at a lower interest than that of your first mortgage than this direct approach will not work. We agree on that. This is one flaw to expose because I've seen explanations on the Internet that assumed you could get a HELOC at a lower interest rate than your mortgage. Maybe there was a time but this time is not now apparently.

I will now investigate the possibility of manipulating the HELOC account. This is the other part of this so-called technique. But so far I agree with you Peter.

December 31, 2011

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Deryck @ 6:26 pm:

To add a little clarity to Peter and Doug's analysi:
Peter, you are correct, if you have extra money AND it's in your financial best interest to apply you can payoff your mortgage quicker….BUT, that's not Doug's point…..You can payoff your mortgage quicker by using your Heloc as a total banking solution AND not have to put one extra penny than your normal monthly budget into the mortgage………Peter, I was a skeptic too….but open your mind for a minute and really run the numbers……..it's overwhelmingly powerful to deposit your entire monthly budget into your first of the month mortgage payment and then pay back your Heloc as your paychecks come in………use a mortgage amortorization calculator that show how much you save versus how much you pay in interest on the Heloc……There is a very simple reason everyone isn't doing this that are able:
It's not worth $3500 and those are the only guys that are teaching the idea…if a consumer advocacy company was teaching it for free everyone would do it…..$3500 for a spreadsheet just spells scam and especially because the companies are set up as multi level marketing companies….The theor though is extremely powerful

May 22, 2012

Peter M Vaughan @ 9:56 pm:

Deryck,
You are incorrect. I notice that your post does not use any example calculation, and the reason is clear. The example calculation clearly show that you cannot borrow money short term at high interest rates to pay down long term money at lower interest rates and come out ahead. You can ONLY pay down your total debt more quickly by applying more money to the debt.
If you borrow 100k for a mortgage, then borrow 5k on a HELOC and pay it against the mortgage, you have a 95k mortgage and a 5k HELOC, so your debt is still 100k.
You will notice that Doug has completely stopped responding to these posts because he has NO factual argument to refuse the statement that your debt only goes down when you pay more. If you would like to run an amortization schedule, make an excel spreadsheet, and post a link showing that there is ANY way that using a HELOC is remotely "overwhelmingly powerful" I will analyze it for you.
The best analysis I have seen showed that a HELOC could, over 30 years, save $50 on a 200k mortgage because it is at a slightly lower effective rate, but only if you get paid twice a month and pay against the HELOC bi-monthly. Of course, with mortgage rates as low as they currently are, and since HELOCs are variable rate loans, over 30 years it is unlikely that this situation would prevail, and it sounds like a lot of work for one dollar and sixty cents a year.
I look forward to seeing your complete amortization schedule and its comparison with the "overwhelmingly powerful" HELOC technique, if you can produce such a document.
Sincerely,
Dr. Peter M. Vaughan

July 18, 2012

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July 23, 2012

Dale H @ 9:23 pm:

Peter, everybody, you are all thinking like rich men. Here I am taking home $925.00 per week with a $230,000 mtg @ 4.25% and my home appraised last year for $310,000. My payment is roughly $1500 per month including taxes and ins. and with 3 kids and my wife and I both working, the extra dollar at the end of each month just never seems to be there. My payment breaks down as roughly $300 principal, $800 interest and $400 taxes and insurance. So now I go get a $2000 dollar HELOC at 4 or 5 % and start making much larger payments each month, or every other month, say just an extra $1500, and since I'm on year 29,(because I refinanced last year), I knock off about 5 months of principal with that payment which takes $4000 dollars worth of interest with it. Now even if it takes me 2 months to replenish my HELOC I have accrued very little interest on that loan. In this example I will save thousands because I will be doing it so early in the life of my 30 yr mtg. Does this make any sense or am I way out there? I only have a H.S. diploma and I know it shows but this seems very basic. Help!
Dale

August 7, 2012

Bill Kiele @ 1:21 am:

I was reading this thread (now three years long!) and as Peter says, one has to look at EXACTLY how each plan's interest is calculated. The typical mortgage Amortization schedule is calculated once per month. If you add principal to a payment to reduce your loan balance, most, but not all, loans will recalculate an amortization schedule for the lower balance and the same number of payments.

The HELOCs have quite a few ways of calculating interest, usually based on the prior months' average daily balance and applies the daily rate to each day's balance–not unlike a credit card. So, if you were to transfer a sum of money from the HELOC to your mortgage at a favorable time of the month–the 1st day of the mortgage month, and you delay as long as possible the paying of bills (changing their due dates, for example) but taking care to account for processing days so you don't earn late fees, the average daily balance can be held to as much as 60% below what the mortgage period balance is.

You have to be very attentive for about a year until you get used to this system. One mistake will offset any gains you make for a month between the two interest calculation systems. The additional benefit, regardless of whether you gain inside the HELOC, is that those larger transfers early in a mortgage's life REALLY knock out the number of years the mortgage is serviced. This is especially true when interest payments are 3 times higher than principal reduction. Once the ratio slips from 3 -to-1 to something less-than 1-to-one, you've crossed over the "knee" and you stop gaining much time in mortgage servicing. And, tax laws change every year, so you need to check with someone smart in your state, because this cannot be done without knowing what your state income taxes are–Texas, New Hampshire, Alaska, and whoever else don't have to sweat that complication.

If you can't itemize, even with a mortgage, then the problem is simpler.

Regards.

In my case, mi esposa wasn't equally commtted to budget control, so I would not be successful in a HELOC plan. But it's a fun game to look at.

August 12, 2012

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December 1, 2012

John @ 6:16 pm:

I ran this thru a few different calculators.

First option straight 30 year mortgage
Second option 30 year mortgage, 85,000 heloc
Third option 30 year mortgage using heloc payment against principal

If you have the money third option was more effective then the second. However there appears to be a possible benefit to the heloc. It could get your money off the sidelines, savings, money markets etc and get it working for you while still giving liquidity for emergencies.

I would like feedback on this strategy as I have money on the sideline. Putting it direct towards principle doesn't give me access to it and it's only earning little in those cash liquid accounts.

Take all savings. Take out the heloc. Pay down the original mortgage by the amount in savings. Heloc is there for emergencies. Do the deposit check thing and continue keep a 0 or low balance on the heloc.

I don't see much benefit in riding the heloc up high,but see it as a good liquidity tool for the equity built up.

Thoughts.

December 5, 2012

Dr. Peter Vaughan @ 10:18 pm:

Dale,
To be blunt, your math is entirely incorrect. To see this, consider taking out a HELOC to pay off the ENTIRE mortgage. Then you've reduced your mortgage by 30 years, but of course it will take you 30 years to pay off the HELOC and you haven't saved anything. The problem comes with the statement "Now even if it takes me 2 months to replenish my HELOC…" This assumes that this is money you are paying in addition to the principal you already pay. Otherwise, you couldn't pay 1500 every other month because you would get behind on your house payment. If you are taking $1500 out of your HELOC every other month and taking two months to get it back to 0, you are paying an extra $750 per month on your mortgage. You bring home 925 a week (46k a year if you work 50 weeks) and pay 1500/month (18k/year) already, that would take your payment for primary mortgage and HELOC to 2250 a month (27000/year). If you could live on 19k a year, why bother with the variable interest rate HELOC and not just pay off the house? HELOCs are both variable rates AND higher rates than primary mortgages. It's not likely the variable rates on them will go down from here. There is NO benefit EVER reported by ANYONE to using a HELOC who has backed up their claim that it works with an actuarial table. The reason is that it does not save you money.
Sincerely,
Dr. Peter Vaughan

Dr. Peter Vaughan @ 10:30 pm:

John,
I have never found a mortgage calculator that gave me calculations from using a HELOC that does anything except possibly save one month worth of interest on the back end of a 30 year loan, in 30 years, assuming the HELOC rate does not rise. The best I have ever seen this strategy do is with getting paid weekly (keeping the average HELOC balance lower) and the result was that in 30 years, you would save an entire $50. And that assumes that HELOCs do not raise their rates for 30 years. Since 30 years ago, we were suffering through stagflation and mortgages were at 16%, that's a bad assumption. If you have some links to share and something that shows this works, please share.
My advice is to put aside cash money for emergencies in a savings account, and just throw the statements into the shredder instead of seeing the pittance you get in interest. Consider it emergency insurance. Insurances costs you money now (in the interest would could make somewhere else) but gives you security (because there are no more emergencies when you have cash).
Then pay off your debt. Once you have no payments, all you have are bills and your cost of living drops dramatically. The amount of money you need to live drops dramatically. And once you don't need so much money, you end up having a great deal of it.
Sincerely,
Dr. Peter Vaughan

December 6, 2012

Dale @ 9:58 am:

Mr. Vaughn, I don't know how to tell you how to open your eyes but you seem very short sighted in your responses to everyone. You obviously see this process with one set of eyes and that's not totally your fault. You probably went to college where they taught you how to think and wouldn't even dream of thinking outside the box. I have a "Dr." friend that works at T D Banknorth here in Maine and he thinks just like you but 3 of his "Assistants" laughed at him for not being open eyed enough to see this. That being said, I would have to suspect that probably you either work at a bank or for a financial institution, maybe even Chase or one of the big ones? The banking institutions control this, and most other countries by controlling peoples financial lives. Most people have been taught their entire lives to get a house, pay a 30 year mortgage, raise their children and pay their taxes. Watch out, The People are waking up. The Feds, the Bilderburgs, and the rest do run the world but we don't all conform!
Have a great day.
Dale
NO Dr.
No PHD
Just Dale

Dr. Peter Vaughan @ 9:58 pm:

Dale,
So you managed to contribute nothing to our conversation except to attack me as some member of a vast banking conspiracy.. If you decide to start making house payments that are $2250 a month while bringing home $3833, I believe that you will quickly find yourself in considerable hardship. Living on less than $1600 a month in very difficult.
If you have anything substantive to contribute to the conversation about how this HELOC is supposed to help you, especially if you have any math this is not incorrect to contribute, I would love to hear it. But in the last 3 years, every time I have looked into using one loan to pay off another, I have rarely found anything that saves money, and the one time I did find a system that saved money, it was $50 over a 30 year mortgage.
If you just want to insult somebody, please feel free to continue. Know, however, that it is not productive.

December 7, 2012

John @ 3:58 am:

Dr. V,
I'm agreeing with you on the paying prinicpal vs the Heloc. I can't seem to find Math that supports the Heloc doing much more that breaking even with paying extra prinicpal payments, but making principal payments does "lock up" your cash and that will reduce the amount of money you pay towards prinicpal.

If you are keeping money side-lined for emergencies and money in a checking waiting to pay bills I believe this has merit. I don't see how anyone can argue that.

Example:
You keep 6 months of income in a money market. You make 5k a month. That money earns .01%. Instead you put it all against your mortgage and taking the HELOC. If you never have an emergency that money has worked far better for you at at your mortgage rate interest vs. your money market interest. On my 571K mortgage 30k on the front end reduces my mortgage my 30 months. I've been working for a little bit now, and I've been fortunate to not have many emergencies. Most/all of which I've been able to pay on a CC and pay off by the next month.

In general I believe this concept could also work for non-emergency funds that are sidelined in your checking etc… All that said once you borrow from the HELOC you pay the interest and you cut into your gains. The HELOC does compute interest daily, saving there is minimal even if you have an even interest rate.

I don't see the downside here unless your emergency is extreme. A little risk could save you money if you are using you Heloc for your emergecy fund.

For me personally I'm willing to take a little risk and I'm taking a HELOC prime plus 1 from PenFed

I would be interested in hearing some reasons not to do this for this specific reason?

Dr. Peter Vaughan @ 11:40 am:

John,
Unless I misinterpret what you said, you are advocating not having an emergency fund, but instead having a HELOC to cover you in emergencies. You said that you would prefer to put 6 months of savings into your mortgage instead of putting it into an emergency fund and have 0 cash. If I am wrong about that, please correct me. If that is was you are proposing, I would say that you need to consider the purpose of an emergency fund. If you have a HELOC that you plan to use for your emergency fund and you do end up having a bad emergency, you could end up losing your home. That is not a risk I would ever take. But personal finance is personal.
-Peter

December 9, 2012

Dale @ 6:18 pm:

OK Sir, try this.

If you follow your idea about taking a HELOC to pay off a mortgage and that's all you do with it then obviously the higher interest rate charged on the heloc makes no sense to use it that way. I suggested using a portion of the line of credit to apply to the principal of your mortgage payment, which eliminates a huge amount of "interest" charged from the 30 year note and if you pay back the HELOC by depositing most of your entire paycheck back into it weekly then the total interest charged from the HELOC will be minute as compared to the savings of interest from the 30 year note. To use simple numbers, If a mortgage payment is $1000 and the first payment is $200 principal and $800 interest, and you take out an $8000 HELOC and use say $5000 dollars, to knock down your principal, that $5000 dollars removes, in theory, 25 chunks of principal from the life of the loan, ($5000 / $200 = 25). Also removed with those 25 chunks of principal is 25 chunks of interest at $800 per chunk or $20,000, ($800 x 25 = $20,000) In this example 25 months of payments have been removed from the life of the 30 year mtg. You have $3000 still in the HELOC in case you get into trouble and even if it takes you a full year to pay back that HELOC you would only have paid say $250 to $500 in interest to that HELOC yet saved $20,000 in interest from your mortgage. Repeat this a few times in the first ten years of a 30 year note and it WILL save you a lot more than what the HELOC will cost you. Seems really simple. Now go ahead and bloviate about why it won't work.
This is simple. This should work. I don't think anyone that works for a Bank or financial institution of any kind would EVER admit to it. It does require thinking "outside the box" and I plan to approach my bank for this loan. I have the equity in my home and I believe that anyone with discipline can use this idea.
Signing off now. I will write back in a year, if we're all still here, and let you know how I make out.

P.S. I will write back even if I'm wrong, and at that point, if I am wrong I will apologize.

Dale

December 14, 2012

Dr. Peter Vaughan @ 9:38 pm:

Dale,
I think there's a problem with your math that comes from not actually considering having two loans out at the same time. You take out 8k in a HELOC and pay it back over a year, so you have to put $417 a month (plus whatever interest) into the HELOC (to repay the 5k, if you want to repay the whole 8k, you need $667 a month), as well as continuing to make your mortgage payments. You don't get to stop paying the mortgage while you repay the HELOC. However, if you have an extra $417 a month after expenses, you can just send that in to your mortgage holder and pay down the mortgage. After one year, you have either taken out and repaid a HELOC, you you have paid down 5k on your primary mortgage. It turns out the in the long run, the difference between these options is the difference in interest payments on the two loans (the net interest spread). In all my research, putting the $417 directly into the mortgage was the best way to go.
-Peter

December 16, 2012

B @ 12:05 am:

How about this scenario…
30 yr fixed mortgage at 3.75% for 500K, Cash flow a month is 9K in take home income, take a HELOC for 200K at 3%, pay the 200K into the Mortgage and have them recast the original mortgage to 300K. Have the Bank redo the HELO to 400K, and take every bit of excess cash…say 100K to reduce the open balance of the Heloc to 100K.

500K loan with payment of 200K from Heloc saves $257K in int, 16 years of mortgage
Recast of 500K loan saves $1000 a month on mortgage
Put 100K into Heloc (that is earning next to nothing plus all paychecks)
If you pay $1000 to the Heloc (assume int stays roughly the same), you pay off that loan in 8-11 years…plus as you pay down loan you have that cash available to you to replace the savings you are missing
As a bonus pickup a $150K condo with the remaining Heloc, make int only payments and cash flow $500 into your Heloc or as extra principal payments to the original mortgage

Dr. Peter Vaughan @ 10:50 am:

B,
Yes, your scenario works because of 2 things. First, you found a HELOC with a lower interest rate than a first mortgage. Second, you assumed that in the next 15 years, this would continue to be true. Since HELOCs typically have higher interest rates than primaries, and their rates are variable, your scenario includes two highly unlikely assumption.
Additionally, if you can find a mortgage with a lower (fixed) interest rate than your primary, it would make a lot more sense to refinance the entire loan at 3% instead of just 200k of it.
-Peter

April 6, 2013

current 30 year fixed mortgage rates @ 5:57 am:

No doubt why you get so many blog comments.

November 1, 2013

voleta R. carig @ 5:10 pm:

I have been studying this book about HELOC for the past 5 yrs. to pay off my loan sooner the thing that holding me up the mortgagebank put our loan to adjustable after the written modification of 444 months with 4.41% on April 2009, do you think I can still apply the principle of HELOC, I am working on the bankj to acknowlegh the notarized agreement that they sign, the same bank approved us for a $50,000 Equity Line of Credit that I was planning to pay more to accumulate money to use paying my mortgage faster.

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