Using a HELOC to accelerate paying off the mortgage?

[Sajimone]

Please forgive me if I might be asking a very dumb question... as Im not mathematically inclined.   I have gone from a Dave Ramsey approach of aggressively paying off the mortgage with extra payments... which has allowed me to pay off half my mortgage and otherwise debt free but the house... to currently a WCI approach which I believe is investing the extra payments into a good taxable mutual fund and one day perhaps pay off ALL the mortgage lump sum.

Now this particular approach of using a HELOC to accelerate paying off the mortgage is interesting but questionable as it uses debt to pay off debt?   But the debt of a HELOC is supposedly different than the amortization of a mortgage loan?   Again, I don't think Im smart enough to understand if this makes financial sense nor am I sure if I can explain it well... so I will attach a link for the basic explanation?

http://www.wikihow.com/Follow-the-Mortgage-Accelerator-Plus-Program

The idea is interesting as if I could use a HELOC of 20-30k to payoff a chunk of the mortgage and save lets say 4-6 months of interests payments, then apply most of my monthly paycheck to the HELOC at the beginning of the month (except all planned savings such as retirements, 529, etc), any expenses such as grocery, gas, utilities all go on the credit card (more points or cashback), then at the end of the month pay off the credit card by withdrawing from the HELOC while still paying the monthly mortgage, and repeat each month until the HELOC is back to zero.   Then repeat this whole cycle again and again until the mortgage is paid off...

Obviously this only works if you're cash flow positive each month and also there's obviously interest being paid into the HELOC as well.. but is there any meaningful savings if you minus the difference of the mortgage-interest-saved by the HELOC-interest-paid?  Perhaps this makes more sense at the beginning of the amortization schedule where mortgage paid is mostly interest and less principal?  And if this does makes sense.. how does this compare to the Ramsey or WCI approach?

I would really appreciate the thoughts from the mathematicians of this community?

[GXA]

 

Seems awfully complicated to me.  With the 10 year treasury at historic lows, you could probably refinance into a fixed 15 at 2.75% (I refinanced into a fixed 15 a few months ago at 2.875%).  These rates are lower than a HELOC, and you are able to maintain a positive cash flow, why not just prepay your new fixed 15 year loan?  Many HELOCs are also variable loans, so whenever the fed starts raising rates, variable loan rates will head upwards.

Sorry I did not include any real math...but if you are able to afford prepaying your mortgage, I do not know why you would use a HELOC to prepay it.

 

[Sajimone]

I can perhaps prepay an extra 1-2 months of principal down.. which I used to do but now apply all extra payments to a taxable mutual fund... but to do 4-6months or more of extra principal payments at a time... I can't.   Hence how the HELOC may become useful?   It's not that it matters what the interest rates are.. it's that when you pay your mortgage in the beginning of the amortization schedule.. you are effectively paying a lot more interest than principal upfront.   This strategy MAY speed up that process up.. I'm not sure?   Also, Im trying to wrap my brain around whether that mortgage-interest-saved significantly outweighs that HELOC-interest-paid.. plus consider the other possible advantages of interest-tax deductions, accelerated mortgage payoff, credit card points?  This strategy sounds like it wouldn't work as well toward the latter half of the amortization schedule as more principal is being paid than interest... and perhaps the HELOC-interest-paid outweighs the mortgage-interest-saved?

[Dicast]

I think the HELOC method is mostly shenanigans.  I looked into these programs after I heard about them on a podcast.  I think the main benefit from using one of these programs is that it is taking all of your surplus money and applying it to the loan each month.  Anyone can save significant amounts of interest on a mortgage by simply taking all of their extra money each month and paying down principal.  I haven't been able to wrap my mind around how having a a HELOC of 3.5% (current rate from my bank) while my loan is at 2.8% makes any sense.  As low as rates are right now, I don't know that you can make a mathematical argument for paying down mortgages fast anyway.  I will put extra on mine because I have an irrational goal of being debt free by 40.

I think the biggest warning for all of these HELOC plans is that they require you to have positive cash flow to make a difference.

Keep it simple.

[Sajimone]

I love simplicity as well!  And after further thought.. Im going to simplify this strategy in an example below but just so you know where Im coming from... I max out all my 403, 457, CAA, ROTH x 2, small business 401k for my wife and myself, 529s x 3 kids ($1.5k/m), and a taxable account ($3k/month) all in accordance to my IPS and mostly in low expense mutual funds.   This mortgage is my only debt left.   I think my problem here is that I see potential mathematical sense especially more so if you're doing this in the early half and perhaps latter half of the amortization schedule?   For example.. again Im not totally convinced myself as its using debt to payoff debt one small chunk at a time.. but if I have a $500,000 mortgage loan at 3.5% interest and I use $10,000 from a HELOC loan at 4.5% ... which is even higher than mortgage interest... then apply the $10,000 to the mortgage principal which is is now $490,000.   I will have saved the interest portion of $1,400 x 10 payments that I didn't make which is more than $14,000+ in interest payments as I have sort-of fast forward the amortization schedule (see attached file)?  Now apply the extra payments to the HELOC instead and the interest I paid on the HELOC loan according to a Bankrate calculator if I paid $1,000/month comes out to be about $211 or if I paid $500 a month.. $414 total interest (see attached file)?   For me if I apply $3k a month to the HELOC.. I would pay only $90 interest?   After the HELOC is fully paid off.. do it again.. potentially knocking off the mortgage in huge chunks?!

From a cashflow perspective or Ramsey approach.. I can certainly apply the $3k a month to the mortgage and save 2-3 months interest payments at a time.  Do this over 3-4 months.. this probably comes close to this HELOC approach.. I don't know?  This is where I need mathematical help...

Is it better to apply the extra payments to the HELOC instead?  Is there a difference between paying off mortgage-interest and HELOC-interest?  Perhaps there's a psychological benefit?  What am I missing?  Appreciate everyone's input!

[Zaphod]

I think this is a convoluted and overly complex system that probably isnt worth the effort. All this effort being applied to a tax deductible inflation hedged asset just doesnt make a lot of sense.

The benefit likely comes from just taking a big one time chunk out of the principal and the ensuing decrease in amortization/interest on principal for the remainder of the term. Its a term and amortization arbitration type strategy. For someone in a position to pay extra payments in the thousands per month anyway, I again dont get it in this particular situation.

There are more productive ways to get fancy with rate/term arbitration. Youre probably better off investing in a taxable anyway and building other things up. Nothing wrong with using debt to pay off debt, as thats what you do with every refinance, it just has to make sense.

[adivjay]

I came across this technique recently and have been debating about this.
After some comparisons, it makes more sense to just use the extra cash flow to make extra payments towards the principal instead of taking a heloc. Loan is paid faster and there is greater interest savings.
It gets better if the extra cash flow is invested in the market. The profit (assuming 8% CAGR based on historical market performance) are better than the interest savings from paying off the loan.

[DMFA]

adivjay wrote:

I came across this technique recently and have been debating about this.
After some comparisons, it makes more sense to just use the extra cash flow to make extra payments towards the principal instead of taking a heloc. Loan is paid faster and there is greater interest savings.
It gets better if the extra cash flow is invested in the market. The profit (assuming 8% CAGR based on historical market performance) are better than the interest savings from paying off the loan.

Click to expand...

If that's the case, isn't it better just to leave the tax-advantaged, inflation-hedged mortgage loan as little as possible and invest the rest in taxable?

Sorry for the odd question, but why do you want to pay off your mortgage so quickly?  Not that I'm opposed to it, but the reason why you might think you want/need to is the most important aspect.

If the OP is in 39.6% bracket, which I can only assume you are since it seems you put over $200,000 in investments every year, then assuming you're not in the deduction phase-out range and the mortgage left isn't > $1,000,000, then the true rate on that mortgage (since interest is tax-deductible) = (1 - .396) * 3.5% = 2.114%.  Let's imagine you don't get a state tax deduction for it (if you do, it's even better).  Inflation in recent decades has averaged around 2%ish.

...so you're in a rush to pay off a 0.114% simple interest loan by taking out a 3.5% HELOC (though being mitigated by the 2% cash back card), as opposed to exposing it to whatever compounding market gains you'll get (8% is being thrown around, so take away 25% LTCG and 2% inflation, so call it 4% compounding after tax/inflation)?  ...can I get the math explained to me?  Mortgage is a great leveraging tool.

The only way I can see that being objectively beneficial is if there's a non-mathematical benefit to eliminating your mortgage, like the psychology of being debt free (understandable), or wanting to retire without debt (very important imo).  The HELOC lender gets your interest and the CC issuer gets the fees of it being used, and after the 2% cash back you get from the CC, you come out not quite as good as if you'd leveraged your near-zero "real rate," simple-interest debt and invested in equities.

...and if you have that much money to throw around, why bother?  Just take the 2% on your purchases with the cash-back credit card without the added mortgage/HELOC loop.  That'll get you a free $200/month on $10,000 of purchases.

[adivjay]

A home is never an asset. Investing in real estate makes sense when incoming rents pay off all expenses and mortgage and leave extra money as cash flow that can help tide some tough market situations. Most people consider primary residence as an asset. I dont think that is the case since there is no incoming rent but only expenses. As a home owner, what we need to be concerned about is the total cost of home ownership (principal +interest+home repairs+ property taxes). I dont buy into the arguement that taxes and interest are deductible. That would be a sound reason to buy a home. A home is not an easily liquifiable investment. Plus it involves pretty high trasaction cost during buying and selling. The only time a home becomes an asset is when it has appreciated more than the purchase price and results in some gain, but no one has control on this factor.

After the housing bubble, a lot of places are still recovering. Given how the demographic trends are emerging, I doubt that home prices will go back to the levels before the crisis with some exceptions such as CA and few other states. Places in mid west are still behind. Home ownership has declined since 2000 but homes have appreciated. So that begs the question what is going on? One possible reason i can think of is that the supply has decreased due to investors buying homes which means people are still not in a position to own primary residence. It is a matter of time. Question is how long? Until then one would have to sit tight and hope for best. From that aspect, I prefer to pay off debt at least 50% if not the whole so there is some flexibility should our circumstances change. I certainly understand the investment logic of why pay a low interest rate loan when there are better investment opportunities. It all boils down to what the financial goals and game plan are to increase assets and reduce risk/ liabilities to increase net worth.

[adivjay]

I meant to state taxes and interest desuction are not a sound reason to buy a home

[DMFA]

adivjay wrote:

I meant to state taxes and interest desuction are not a sound reason to buy a home

Click to expand...

Oh, I was about to say "what?!?" but now I get what you're saying.  The only reason to buy a home is to buy a residence.  The deductions on tax and interest just reduce the amount; it's still an amount to pay.  No one should ever spend for the sake of getting a deduction; you're still spending, just spending less. It's just simply a decision as to what to do with the mortgage debt once you've got it.

That being said, the only point I'm trying to make is leverage.  That debt is amortizing the same regardless of what inflation is, and even if inflation has been only 1% like it has been in the past couple years, and especially for longer terms (such as 15-30 years), the math does not support eliminating that near-zero real rate of non-compounding debt in favor of placing it in equities over the long term to earn compound gains on re-invested dividends.  Obviously we don't have the crystal ball to know how these things will work year-by-year, but over the long-term (even prob for short), it's more likely better in the market, although it's never really *wrong* imo to eliminate one's debt.

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[q-school]

DMFA wrote:

adivjay wrote:

I came across this technique recently and have been debating about this.
After some comparisons, it makes more sense to just use the extra cash flow to make extra payments towards the principal instead of taking a heloc. Loan is paid faster and there is greater interest savings.
It gets better if the extra cash flow is invested in the market. The profit (assuming 8% CAGR based on historical market performance) are better than the interest savings from paying off the loan.

Click to expand…

If that’s the case, isn’t it better just to leave the tax-advantaged, inflation-hedged mortgage loan as little as possible and invest the rest in taxable?

Sorry for the odd question, but why do you want to pay off your mortgage so quickly?  Not that I’m opposed to it, but the reason why you might think you want/need to is the most important aspect.

If the OP is in 39.6% bracket, which I can only assume you are since it seems you put over $200,000 in investments every year, then assuming you’re not in the deduction phase-out range and the mortgage left isn’t > $1,000,000, then the true rate on that mortgage (since interest is tax-deductible) = (1 – .396) * 3.5% = 2.114%.  Let’s imagine you don’t get a state tax deduction for it (if you do, it’s even better).  Inflation in recent decades has averaged around 2%ish.

…so you’re in a rush to pay off a 0.114% simple interest loan by taking out a 3.5% HELOC (though being mitigated by the 2% cash back card), as opposed to exposing it to whatever compounding market gains you’ll get (8% is being thrown around, so take away 25% LTCG and 2% inflation, so call it 4% compounding after tax/inflation)?  …can I get the math explained to me?  Mortgage is a great leveraging tool.

The only way I can see that being objectively beneficial is if there’s a non-mathematical benefit to eliminating your mortgage, like the psychology of being debt free (understandable), or wanting to retire without debt (very important imo).  The HELOC lender gets your interest and the CC issuer gets the fees of it being used, and after the 2% cash back you get from the CC, you come out not quite as good as if you’d leveraged your near-zero “real rate,” simple-interest debt and invested in equities.

…and if you have that much money to throw around, why bother?  Just take the 2% on your purchases with the cash-back credit card without the added mortgage/HELOC loop.  That’ll get you a free $200/month on $10,000 of purchases.

Click to expand...

out of curiosity, you like to retire without mortgage debt, even though mathematically there is still expectation of positive return from investments/inflation/etc?

or at that point you likely have exhausted the interest benefits, your income tax rate is likely lower, and so the calculated return changes to a negative amount?

thanks

 

[Zaphod]

q-school wrote:

DMFA wrote:

adivjay wrote:

I came across this technique recently and have been debating about this.
After some comparisons, it makes more sense to just use the extra cash flow to make extra payments towards the principal instead of taking a heloc. Loan is paid faster and there is greater interest savings.
It gets better if the extra cash flow is invested in the market. The profit (assuming 8% CAGR based on historical market performance) are better than the interest savings from paying off the loan.

Click to expand…

If that’s the case, isn’t it better just to leave the tax-advantaged, inflation-hedged mortgage loan as little as possible and invest the rest in taxable?

Sorry for the odd question, but why do you want to pay off your mortgage so quickly?  Not that I’m opposed to it, but the reason why you might think you want/need to is the most important aspect.

If the OP is in 39.6% bracket, which I can only assume you are since it seems you put over $200,000 in investments every year, then assuming you’re not in the deduction phase-out range and the mortgage left isn’t > $1,000,000, then the true rate on that mortgage (since interest is tax-deductible) = (1 – .396) * 3.5% = 2.114%.  Let’s imagine you don’t get a state tax deduction for it (if you do, it’s even better).  Inflation in recent decades has averaged around 2%ish.

…so you’re in a rush to pay off a 0.114% simple interest loan by taking out a 3.5% HELOC (though being mitigated by the 2% cash back card), as opposed to exposing it to whatever compounding market gains you’ll get (8% is being thrown around, so take away 25% LTCG and 2% inflation, so call it 4% compounding after tax/inflation)?  …can I get the math explained to me?  Mortgage is a great leveraging tool.

The only way I can see that being objectively beneficial is if there’s a non-mathematical benefit to eliminating your mortgage, like the psychology of being debt free (understandable), or wanting to retire without debt (very important imo).  The HELOC lender gets your interest and the CC issuer gets the fees of it being used, and after the 2% cash back you get from the CC, you come out not quite as good as if you’d leveraged your near-zero “real rate,” simple-interest debt and invested in equities.

…and if you have that much money to throw around, why bother?  Just take the 2% on your purchases with the cash-back credit card without the added mortgage/HELOC loop.  That’ll get you a free $200/month on $10,000 of purchases.

Click to expand…

out of curiosity, you like to retire without mortgage debt, even though mathematically there is still expectation of positive return from investments/inflation/etc?

or at that point you likely have exhausted the interest benefits, your income tax rate is likely lower, and so the calculated return changes to a negative amount?

thanks

 

Click to expand...

Math wise, liquidity wise, insurance wise (anything could happen), etc....a mortgage in retirement or simply renting makes excellent sense. Some of the risks will be more or less depending on the natural disaster profile of where you live as well.

Its just one of those things where i guess if you're in a position and you should have the cushion I guess. Idk, if some banks give mortgages to 80 year olds, etc...they get what they deserve.

[Keisha22]

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