I had someone on the podcast a while back that was a big fan of mortgage acceleration for paying off your mortgage faster. Like a lot of complex financial products, those who can make a buck off of it say it's magic. They say things like, “Instead of paying off your mortgage in 30 years, you can pay it off in 7!” But when you dive deep down, you see that while there may be something worthwhile there, you don't have to pay too much in fees and extra costs to eliminate the benefit. Let's do a deep dive.
Biweekly Payments
First of all, there's some confusion on the internet about what mortgage or equity acceleration really is. People are using the phrase for two different things. The first is a biweekly payment system. This is where you pay half your mortgage payment every two weeks (presumably as you get your paycheck.) By the end of the year (52 weeks long) you've made 26 half payments instead of 12 full payments. Plus, you're basically paying two weeks ahead, which saves a sliver of interest and slightly accelerates things. But the main benefit is just paying more than the minimum due. By paying that extra payment you knock a few years off your mortgage.
My calculations show you knock 4 years off of a 30 year, 4% mortgage or 16 months off a 15 year, 3% mortgage doing this.
Fair enough. Alternatively, you could just pay a little extra principal with each payment and get the same thing.
The problem comes when the lender or a third company charges you an extra fee to do this. That extra fee would reduce and perhaps even eliminate the benefit. So if you want to do this, just set it up yourself with an auto-transfer.
Using a HELOC
The real scheme I want to discuss is a little more complicated. It involves replacing part or all of your mortgage AND your checking account with a Home Equity Line Of Credit (HELOC). Say what? Don't worry, I'll explain. It's not that complicated. It's actually pretty clever, but it's not quite the magic bullet its proponents would have you believe.
Here's how it works. Let's say you get a mortgage. We'll make it a $400,000, 4%, 30 year fixed mortgage. Cool. You make that $1,910 payment every month for 360 months and you'll be debt-free.
But 30 years is a long time. So instead of just putting that mortgage on auto payment, let's say you did something else. You took out a $100,000 HELOC. Now you take that $100,000 and you pay down the mortgage with it. So now you've got a $300,000 4% fixed mortgage with a payment of $1,910. At that rate, you'll pay off the mortgage in 223 months, or just shy of 20 years. You knocked 10 years off your mortgage! Cool!
Wait. What about the HELOC?
Except you still have that $100,000 HELOC. Which is probably at a higher rate than your mortgage (perhaps 5%). And the rate is variable. And you probably had to pay for an appraisal and maybe even some other fees to get it.
Now your move doesn't sound so smart, does it? You just traded a lower fixed rate loan for a higher variable rate loan. HELOCs are also often interest-only, which is convenient, but if you just paid the minimum payment for 20 years, you'd still owe all $100,000 and you would have paid more interest over the years than if you'd just kept the boring old 30-year mortgage.
But here's where the fun comes in. Now instead of using a checking account paying you 0% and a savings account paying you 1%, you just use the HELOC. Your paycheck is deposited into the HELOC (decreasing the size of the debt) and your mortgage and other payments (hopefully consolidated on one credit card) are paid from the HELOC (increasing the size of the debt.)
Since interest is calculated based on the daily balance, there is usually LESS than $100K in debt. You do carry a balance in your checking and savings accounts, right? So if you've “got $50,000 sitting in the HELOC,” meaning you really only owe $50,000 on it, then the interest is half as much as it would otherwise be. And in fact it is LESS than what it would cost you even at a lower interest rate if you had just left the money in a savings account and earned 1% on it.
Think about it:
- 1 year's worth of interest on a $400K 4% mortgage = $16K, maybe $9,600 after tax, plus
- 1 year's worth of interest on $50K in a 1% savings account = $500, maybe $300 after tax.
- Put it together and you're paying $9,300 in interest.
But
- 1 year's worth of interest on a $300K 4% mortgage = $12K, perhaps $7,200 after tax, plus
- 1 year's worth of interest on a $50K 5% mortgage = $2500, perhaps $1,500 after tax equals
- $8,700 worth of interest.
Meanwhile, that extra $600 is going toward paying down that HELOC/mortgage combination even faster.
Perhaps you get the float on your credit card too. Let's say that gives you six weeks worth of $5K, which is a few dollars more.
And as the HELOC gets smaller, eventually you can take some more out of the HELOC and put it against the regular mortgage, further accelerating things.
Will that all help you to pay off your mortgage sooner? Sure will. But not magically. You see, in order to do the really magic stuff (some of these guys promise to help you pay off your 30-year mortgage in 7 years) there is one more part to the puzzle. That part involves paying more toward the mortgage/HELOC each month than you otherwise would have. If you spend less than you earn (which is a good thing that I'm very much in favor of) then that extra money sits in the HELOC. But that's precisely the equivalent of using the difference between what you earn and what you spend to send in an extra mortgage payment. Sure, you get a few extra days worth of interest savings messing with the HELOC, but the bottom line is you're making a bunch of extra payments without realizing it. It's a behavioral solution, not a mathematical one. I mean, alternatively, you could be investing that money and perhaps even making a better return than you're getting paying down your mortgage/HELOC and then turning around and paying off the mortgage with the investments once they equal the mortgage.
The Downsides
Interest Rate Risk
There are a few other risks that probably ought to be considered here. First, it's a variable rate loan. So if rates rise dramatically, you're now stuck with a HELOC at 6%, 7%, 8% or even higher. At a certain point, you're going to be better off with just your regular old fixed rate mortgage.
Behavior Risk
Another risk occurs if you don't actually spend less than you earn. In that case, all the wand-waving that fools you into paying extra on your mortgage works in reverse and you're actually using that HELOC as an ATM. The system works a little bit if you can only manage to spend exactly what you earn, but in order for it to really work, you've got to be “making those extra payments” by spending less than you earn and leaving the difference in the HELOC.
Opportunity Cost
Another risk is that you could be passing up on better investments in order to pay off your mortgage early, which is generally considered a fairly low returning investment. Paying off a 4% mortgage when you could be earning 5%, 7%, 9% or more isn't exactly a winning move. It's a downright stupid move if you're missing out on an employer 401(k) match. But I would argue it could be pretty dumb if you're missing out on maxing out any type of tax-protected account. That tax break is huge for high-income professionals and I rarely advocate paying off a low rate mortgage if you're not investing anything in a taxable account. There's also an asset protection angle here. In most states, most of your home equity is available to creditors, but your retirement accounts are not. So you're missing out on additional asset protection too.
Risk of Picking Wrong HELOC
Yet another risk is that you might not pick a very good HELOC. Perhaps there was a 4.5% one available somewhere and you picked one that costs 5.5%. Or it has high fees.
Risk of Paying Too Much in Fees
In order to avoid that problem, some people hire a company to help them do this. That company picks the HELOC for you and teaches you how to do all this, but they want to make a profit too. Guess where that profit comes from? That's right, your pocket. The more you pay in fees, the less benefit you're going to see from doing this.
Credit Card Related Risks
It sounds like most people doing this are using a credit card. Not only do you get to “invest” the float, but you may also get some reward points. Two issues with that. First, the data is pretty clear that we spend more when we're using cards. If you really need or want to get out of debt, you're probably better off going to a cash budget. Second, most people who use credit cards don't manage to pay off the balance every month. You don't have to carry a balance on a credit card very many times before the cost of doing so outweighs any possible benefit you're going to get from a mortgage acceleration program. You won't be surprised to learn that Dave Ramsey thinks this is all a big scam.
Similar to Bank On Yourself/Infinite Banking
In a lot of ways, mortgage acceleration using a HELOC is similar to one way that insurance agents sell whole life policies. They encourage you to be your own bank, borrowing from the policy instead of keeping your money in a savings account. You try to mitigate all the downsides of whole life insurance and there are obviously some costs up front for 5 or 10 years. But in the very long run, you're basically earning 2-5% on your savings instead of 1%. And you get some sort of a death benefit depending on how much of the cash value you use. When you break through all the smoke and mirrors, that's basically what it comes down to. You pay a bunch of fees and opportunity cost up front in return for making a couple percent more on your savings in the long run.
The issue with both schemes is that their benefits are dramatically oversold (usually while minimizing the downsides) such that it causes many people to engage in them rather than doing something even smarter with their money, like maxing out retirement accounts. The minor benefits you do get with either scheme are probably just fair payment for the additional risks and hassle you took on.
An Alternative Mortgage Payoff Plan
So you're interested in being rid of your mortgage in 7 years instead of 30? Okay, you've come to the right place. I've actually got a little bit of experience in this. We paid our mortgage off in about 6 1/2 years. That's right. We paid off our home in less time than many of you pay off your educations. Maybe I should market The White Coat Investor Mortgage Acceleration Plan. Here are the components:
# 1 Don't overconsume housing
Keep your mortgage to less than 2X your gross income in the first place. Not only is it a smaller loan to pay off, but it improves your cash flow. And that's not even considering the transaction, insurance, maintenance, furnishing, repair, and upkeep costs associated with a more expensive home.
# 2 Put down a 20% down payment
Doctor loans are great, but there's something to be said for a conventional, 20% down payment. To start with, that 20% down reduces your mortgage by, well, 20%. You're already 1/5th of the way to your goal before you leave the starting line! Those financial muscles you used to deny yourself while saving up that 20% are also going to help you to pay off that loan faster. In addition, you have a lot more lenders to choose from and can get the very lowest fees and interest rate available.
# 3 Get a 15-year loan
We took out a 15-year loan. We refinanced it at no cost about a year later (which restarted the clock), but the point is that it wasn't a 30-year loan. Not only does that ensure we were making larger regular payments, but we also received a lower interest rate than we would have had on a 30-year mortgage, allowing even more of that larger regular payment to go to principle instead of interest.
# 4 Max out retirement accounts
We've always maxed out our retirement accounts. This allowed us to build wealth quickly and protect it from creditors. We NEVER paid extra on the mortgage while we had available retirement account space. Long-time readers know we have LOTS of tax-protected accounts available to us (over $200K in 2017), so that actually delayed us paying off our mortgage a lot more than it would most of our readers. But borrowing money at an after-tax rate of less than 2% in order to max out a Roth IRA invested aggressively or to take advantage of the tax rate arbitrage available in a tax-deferred account (and the asset protection available in most retirement accounts) is a no-brainer.
# 5 Send some of your taxable investment money to the mortgage company
Once you've maxed out your tax-protected accounts, it's a little more reasonable to pay down the mortgage instead of investing. Maybe you don't want to send in everything above and beyond the retirement accounts, and that's fine. As long as it's going toward building wealth, both investing and paying down the mortgage are good things to do. We don't need to get dogmatic about it.
# 6 Use windfalls to pay off mortgage
At some point in our life, most of us get a windfall of some kind. Perhaps it is an inheritance. Perhaps you just made a little more than you expected. Or spent a little less than you expected. Or decided you didn't want to own that wakeboat after all. Great! Send it in to the mortgage. Our big windfall was The White Coat Investor, LLC becoming financially successful. Yes, we spend a little extra. We give away a lot more (more than we spent in 2017). But most of what WCI made in 2016 that didn't go toward taxes, charity, or the individual 401(k)s went toward the mortgage in three big payments. And honestly, we could have done it about a year earlier than we did but chose to invest the money in taxable instead (and actually came out ahead for doing so.)
There you go. Mortgage acceleration. And you didn't even have to fuss with a HELOC. But if you want to do the magic version of mortgage acceleration, I don't think you're stupid. Just make sure you're aware of the risks, do what you can to mitigate them, avoid any significant fees, and stay disciplined. It may help a little.
What do you think? Do you do mortgage or equity acceleration? How did it work out for you? Do you feel that this technique is oversold? Why or why not? Comment below!
I like your plan much better. It is intuitive and simple. Yet achievable.
I am going to throw the HELOC stuff into the “if it seems too complicated, I probably don’t need to invest in it” category. Anything that seems like that kind of gimmick usually means you cannot afford to do what you are wanting to do at that moment. The way you describe it very much feels like using a credit card to finance something. Sure, you can “have it now,” but at what cost?
The principle behind investing is to keep your risks mitigated while giving you the biggest ROI. Not sure that a HELOC does this. I’ll be interested to see what those in favor of using it say.
One more important point is that with the recent tax law changes, there is less advantage to paying down a mortgage slowly (most of us employed doctors will now be taking the standard deduction at least every other year). We are putting in extra principle payments towards our 30 year as interest rates have risen making refinancing to a 15 year unattractive. I suspect the ongoing interest rate risk will make the HELOC idea less attractive as well.
Being an employed doc has little to do with whether you itemize or not. Think about your main itemized deductions- mortgage interest, state and property taxes, and charity. None of that changes as a business owner.
While the new tax law changes may make it less advantageous to pay off a mortgage more slowly, contrarily, rising interest rates may make it less advantageous to pay off a mortgage more quickly. If you refinanced when rates were in the 2’s, and now long term treasury yields are in the 3’s and trending higher, the math vs. the value of being debt free debate becomes interesting.
That podcast was interesting, but the guy also just oozed “I’m here to pitch my products.”
This comes under the heading of “Don’t Poke a Skunk.” There are lots of ways to get your mortgage paid off early and none of them are simpler than to just send in the extra principle payments with the regular payment and include a note to tell them you want to apply the extra money to the principal. Any other plan is extra busy work with little return. You should never pay anyone to “set up” a way to accelerate your mortgage. Never pay for things you can get for free.
I did pay off my mortgage rapidly, about four years. Not having a home mortgage payment is very rewarding. I haven’t had one since 2001. That is a lot of extra money available every month for spending or investing. You will love that.
Dr. Cory S. Fawcett
Prescription for Financial Success
Author of “The Doctors Guide to Eliminating Debt.”
Life is complicated enough without trying to overthink it. I agree-just pay extra principle if you have the extra cash or windfall. I just see what principle is being paid currently each month and double it from time to time. There is nothing better for the consumer than a 30 year mortgage at a low fixed interest rate that can be prepaid but that can’t raise the rate.
I paid off my mortgage in my early 40s also. Is it a trend? I listened to that podcast also. I see no reason to do it that way. I just made extra principle payments.
After listening to the podcast, I was intellectually curious enough about the method to search for it on the internet to make sure I understood how it worked. As I suspected, there were large fees associated with the group your guest was pushing. Bottom line- he’s a salesman masquerading as a “consumer advocate”, and if I remember correctly, he also had another 1-2 financial products that he referred readers to as well. If i’m being 100% honest, I was disappointed that you gave him the platform to pitch his affiliated products without a stronger debate in the actual podcast, but I appreciate the fact that you followed up in a timely manner with this post to hopefully set folks straight.
Keep up the good work and don’t let down your guard!
Same here, and well said. I still have immense respect for WCI, as I’m sure most all of us do; that podcast just seemed remarkably misaligned with the goal of connecting readers/listeners with “the good guys”. I’m likewise glad to see this blogpost followup; I just wish there’d been more context within the podcast itself, maybe even as an editorial PS, especially for future listeners who won’t get this post in their inbox a couple weeks later.
I’m apparently never going to hear the end of that podcast. But controversy does sell. Everybody remembers that one. It had 15 times as many comments on it as any of the others.
This is the second time I heard this guy pitching this idea. The first time brought back memories from 25 years ago when a new “financial advisor” sat in my dining room explaining to me the “math” behind the benefit of a whole life policy. I am pretty good with math and I began to think if it is that complicated that I do not really understand why this is good for me, maybe I should not be doing it. That is when I realized I better learn this stuff myself or I will get eaten alive by these people. Same thing here, when someone says just paying extra towards your mortgage is too simple to work well, that is when you should say it is too simple not to work well.
I’m in the military, and even on a more meager income, managed to pay off my $280,000 mortgage in 6 1/2 years.
I am definitely against any type of mortgage acceleration plan where you juggle around HELOC’s, interest rates, and deal with extra fees. You can do all of that yourself by simply paying it off faster. Certainly someone telling you these plans are a better way to go would be full of it.
I like the pretend refinance, where you pretend you have a 15 year mortgage, and keep your 30 year. Better for those with lower incomes, or less stable jobs. I like throwing windfalls and side hustles at it.
While pa
Personally, I have always paid down my mortgage down to five or two years. However, all of my mortgages have been at rates of 7.5-10.5% despite my excellent credit history. Yes, rates were that high in 1985-2000.
At 3-4%, I think that I would not pay down the mortgage until I had maxed out on all the tax deferred opportunities (i.e., 401(k), IRA, etc.) that I had available.
What I find troublesome these days is that when many people relocate from a HCOL location to a LCOL location, they often don’t take advantage of that when it comes to housing. I see people moving to Arizona from an $800k home in SOCAL to an $800k house in Arizona rather than a $300k home that is the same size as their former residence. Of course, that increases their fixed costs which means that they cannot save as much.
I hadn’t heard of HELOC etc when I bought homes. But we followed WCI’s plan on our own, going for the lower int rate of 15 year, paying extra now and then and just a few years back when we retired (and no longer had tax sheltered pension accounts to max out, and wanted rid of the monthly mortgage payment).
Having once (en route to GERMANY!) paid an extra $1000 on my student loan and not had that extra digit noted (though debitted from my checking account) in my balance I always triple check though that the principal was applied as intended. Sometimes they want to use it to pay off the next few months’ PITI and not fully reduce the principal and I’ve had to be stern about that.
I follow the ‘if I can’t comprehend it (how it is profitable for me) I might be the one getting duped’ rule so I barely own bonds let alone whole life. Luckily (in 1995) a charming financial advisor lost our business when I realized he was not accounting for the 15% loss in taxes we’d pay by converting all our accounts (including IRAs) to his firm’s funds and then paying him 1% to manage for us. Since the fee hadn’t raised enough red flags.
Great review of this idea and nice to have follow-up from when it was introduced on the podcast. While many now will not deduct home mortgage interest with new tax law, the possibility still exists with the mortgage but not the HELOC. How does that change the math?
It makes this less attractive- basically your effective HELOC rate is higher.
Yeah the biggest disadvantage to this now is HELOC interest no longer being tax deductible.
We only put 5% down on our house, but also got a house that was “only” 1.1x my annual salary and a 15-year mortgage. Our current rate is so low (2.875%) after we refinanced about a year ago (and 2.5 years into our former 15-year term) that I’m not in a huge rush to pay it off aggressively, and am instead trying to beef up our taxable account.
My current mortgage acceleration plan is keeping our old payment amount with our current refinance. It’s onky $400 per month but was what we were used to paying anyway, and keeps us on track to have it paid off in about 11.5 years when our original 15 year mortgage would have been gone. That will also free up cash flow for us to be able to cash flow kids’ college expenses should their 529s be insufficient right around the time all 3 are in college.
For the past 2+ years I’ve invested extra payments to a mutual index funds as my early payoff to the mortgage. I’ve looked at this acceleration program twice over the years and initially felt that this could work but when you get down into the details of it all.. the extra work and effort didn’t seem worth it compared to just simply paying extra to the mortgage or toward a mutual fund. Mathematically this made more sense.
That said.. I think its good to have a HELOC immediately available for the INVESTOR. They’re some upfront cost to it but other than that, no ongoing cost if no balance. And the value in having one available is to be ready for any great deals where you want to pay all cash with the incentive of getting a large upfront discount that more than makes up for any cost or fees for the HELOC itself! I’m currently closing on a commercial property where I am using the HELOC to help purchase the property. My equity in the house is probably not going to make more than 2-3% but compare to an investment property where the return can be 20-30% return ON investment can make a lot sense. And my return OF investment can be within 5 years of the purchase.
Some real estate investors use a whole life policy for similar reasons. Different strokes for different folks. Certainly liquidating (or borrowing against) some mutual funds works too, you just have to weigh the costs against the taxes.
Great post. I’ve had this question asked to me several times. Personally I wont be using an accelerator. I think my wife is starting to see the value of our 15 year 2.875% interest rate and she is less inclined do dump money in for a rapid payoff. I figure we will set up a “mortgage payoff” account to place the extra funds instead. High yield online savings interest isn’t too far from matching our after tax. Maybe a few more interest rate hikes and it will make early payoff a losing bet.
We did that (a side mortgage pay off fund) for a couple of years, then it just seemed silly so we paid the mortgage off. It’s nice to have improved cash flow but didn’t make a huge difference either way for us.
First time poster, thanks for all the knowledge! Should we be concerned about the liability implications of having a paid off home mortgage (varies by state)? Even though paid off, will there be protection from homestead, as your state allows?
As your state allows.
Should you be concerned? Well, I’m not. I have a big fat umbrella policy, reasonable malpractice insurance, and the knowledge that the likelihood of an above policy limits judgement on me is 1/10,000 per year. So I’m not concerned, but that doesn’t mean you shouldn’t be.
WCI has some nice posts on asset protection and how concerned you should be about personal asset protection. They are good reads.
Equity in your home from a paid off mortgage can be a great way to protect assets. Many states exempt your homestead from creditors if you are married and your home is titled correctly with your spouse. If you and your spouse are both named in the lawsuit though, you are probably out of luck!
Banker’s perspective: How do I get people with good credit to pay interest on their savings account and home equity? Convince them to turn those assets into HELOC loans.
The HELOC Mortgage Payoff Scheme is interesting: pay off one loan with another loan if the HELOC offers a lower interest interest rate with minimal fees ($75ish)–like a cheap way to refi. A couple big points that all the other online articles are ignoring is that paying off a home mortgage does not eliminate interest. The mortgage interest is converted to interest on the HELOC–which can be good if the new rate is much lower. In WCI’s example, a $400k mortgage was replaced with a $300k mortgage plus a $100k HELOC.
The other point is that depositing your pay check into the HELOC acct is that you are now paying interest on your “checking” acct, which is free in a traditional checking acct. So imagine paying the prime rate (4.5%) or at least the introductory 2% rate on your entire checking account instead of having the banks pay you interest–this is probably why banks offer HELOCs. Also, if living expenses are paid out of HELOC then you are not really paying down principle much more than if you just put all your extra cash flow into a mortgage.
Some say that putting money into a mortgage is money you can’t get back. So if you have an emergency, then you are stuck with no cash reserve. Same with HELOC, you have no reserves, but you have easy access to credit to get you through. But you can pay off your mortgage and still have the option to use a HELOC in emergencies only.
The HELOC Payoff strategy can be helpful in certain situations—like paying off high-interest credit cards. Otherwise it seems like a lot of work for limited benefit. The biggest risk to the strategy is that people with good finances can get sucked into using debt for everyday expenses.
I think you’re misunderstanding a little bit. You’re not paying on the money that would be in checking. Imagine if you have $50K in checking. So you take out a $100K HELOC and put it toward your $300K mortgage. Then you use the $50K to pay down the HELOC. You now have a $50K HELOC and a $300K mortgage and no checking account. So instead of earning 0.01% on your checking, in essence, you’re now earning the HELOC interest rate on your checking.
WCI,
Thanks for the response!
My thought is that if I had $50k in cash for the mortgage, then I could just pay the mortgage principal. I’d be earning the mortgage interest rate on that $50k. Is there an advantage to adding a step with the HELOC? Is my math off?
Sure, using your cash reserve depletes your liquidity. And the HELOC scheme also acts like a revolving line of credit. The typical scheme calls for all your paychecks to be paid toward your HELOC, then all your expenses paid out of the HELOC. It is like using a low-interest rate credit card that you pay off every month. But then, you are exposed to all the pitfalls of credit—if you aren’t fastidious about bookkeeping.
At the end of the day, this scheme is all about spending your current cash, then using tomorrow’s paycheck to pay today’s expenses. It sounds like the white collar version of a Payday Loan.
I think that’s a little on the harsh side. You’re exchanging a position where you have cash earning little and a little more debt for no cash and a little less debt. For giving up your liquidity, you spend a little less on interest. You just need to be careful you don’t get burned on fees or irresponsible use of the debt.
I too listened to the podcast and was interested to learn more but it did sound too much like a sales pitch. Thanks for the additional info. I think if we decide to work on paying the mortgage off sooner we’ll just send extra cash from bonuses or whatever (my husband prefers to put extra cash in taxable instead of the mortgage so we haven’t done it yet, but as you said, neither is a bad decision)
We just bought a $430,000 home and were offered 2 types of loans:
Option 1:
– 10% down
– 10% HELOC on a second position loan (current rate 4.5%)
– 3.875% 15/1 ARM on a 80% first position loan
(this is essentially putting 20% down, resulting in no PMI)
Option 2:
– 10% down
– 3.875% 15/1 ARM on a 90% first position loan
(no PMI on this either)
I took the option with the HELOC over the whole loan being 3.875%.
Why take the HELOC if it has a higher rate? Well, there were no zero extra fees involved with getting the HELOC since I had it originated with the first position loan. Plus, I had an extra 20k sitting around in savings, expected positive cashflow every month (+bonuses throughout the year). Throwing just 20k into the HELOC instantly cut it’s principal of it in half, plus it still allowed me access in case I needed it.
People keep saying a HELOC is a bad idea because it’s a higher rate, but it’s really not considering how much principal you can kill off early WHILE still also keeping the security of having access to that cash. Extra payments into your main loan is instantly gone — you don’t have access to it anymore (unless you open up a HELOC later or sell your home).
Keep in mind, banks usually won’t give you a HELOC unless you’re LTV is below 80% and they’ll only give you the difference after that. By opening the HELOC right away, we probably saved ourselves thousands of dollars in interest while also keeping access to anything extra we put in. Interest on the higher rate is way less considering the chunk we put in up front + the bi-weekly paychecks that lower it more. We’re looking at paying off the HELOC in less than 3 years with the accelerated method and at that point, principal payments would be significantly higher than interest payments on the main loan, which means we can reroute those extra payments into higher rate investments and maxing out retirement accounts (we’re both putting up to employee matching right now, plus a little more while quickly paying down the HELOC up front).
It’s definitely not for everyone, but if you’re vigilant, you can save tons in interest in just a few years, with little risk.
I disagree that putting 10% down and getting a 10% HELOC is similar to putting 20% down. It’s far more similar to putting 10% down. I also disagree that you can save “tons of interest.” You can save a little interest as illustrated in the post. If that’s worth the hassle to you, then go for it. If it’s not, then just send in some extra payments.
It definitely is reducing a ton of interest. 20k up front that usually wouldn’t have been thrown in plus quarterly bonuses plus extra payments biweekly in the form of 2 entire paychecks and then withdrawing only once a month when you need to to cover usual expenses… It eats up all the interest up front, early in the loan when the balance is at its highest…
Um, no it doesn’t. You’re either being dramatic or you can’t do math. You’re still paying interest on 80%+ of the mortgage, That isn’t “eaten up.”
The idea is to enable the “eating up”. Heloc is the way to do it quickly by treating it as a checking account for savings and positive income. You’re missing the tool to get there. What you need is to think a little out of the box.
What am I missing that wasn’t described in the post?
Here are whats different in your post vs what I had done (mine is a bit smarter):
Your post: you said the 400k loan would be $1,910/mo, then getting a 100k HELOC to pay that down to 300k, while still paying $1,910/mo into the main loan.
What I did: for a 400k house, I got a 40k HELOC and 360k main loan. My monthly payments on the main loan are amortized on 360k, and not on 400k like in your situation.
( I would suggest anyone who’s doing a refi or new purchase do it this way. I did this on a NEW purchase )
That extra difference is amortized mo payment (hundreds/mo) is flowing into the HELOC instead, along with extra savings, paychecks and bonuses, all while keeping access and keeping mo payments down. Not only do you keep lower mo payments, but pay down faster. Plus, you can choose to pay just interest on the HELOC for the draw period, which means extra security and flexibility if you are not able to do pay for some reason.
HELOC in this manner is better.
You’re just recommending getting the HELOC up front instead of later to reduce the required mortgage payment. Okay, that’s fine. Not convinced it makes a huge difference, but honestly not convinced anything about this makes a huge difference. A few little tweeks that maybe reduce your interest a bit.
I wrote my own excel sheet that compares both the flat 4% conventional over 30yrs vs the 3.875% ARM + 4.25% HELOC (in my situation for 430k home, 10% down). The below is assuming no PMI.
Focusing on just the key thing the HELOC would enable for me: just putting 20k up front into the HELOC right away saves 8k in interest in 7 years, 17k in 15 years. Basically, it’s making the money in your low interest savings, work for you instead of against, whilst still making it accessible if you need it. (btw, this is also costing ~$150/mo less than conventional when you total both loans payments).
Paying down faster with just two 5k bonuses a year (2 working individuals), it’s 13k less interest in 7 years, 32k less in 15 (killing the HELOC in just under 3 years).
Add in depositing full paychecks into it and withdrawing just once a month and you’ll save a good chunk more (not going to bother calculating that), but I’m sure that HELOC will be done in just about 2 years.
There’s nothing out there that will let you pay down 43k in 2-3 years, except this feature, used in this way. That’s more than most people’s student loans.
Why are you comparing apples to oranges? Why use an ARM on one side and a FRM on the other?
At any rate, yes, if you put an extra $20K toward your loans you save on the interest on that $20K. I don’t think anyone is disputing that. If you prefer a line of credit to money in your checking account, you can save a few bucks of interest. But the only way you can save the amounts of interest you’re discussing is taking money you were using for something else and putting it toward the home.
There’s lots of “things out there” that will let you pay down $43K in 2-3 years besides using a HELOC used in that way and that’s not even close to the average amount of student loans of the typical reader of this site. For instance, I paid off about $270K on my mortgage in less than 2 years with the White Coat Investor Mortgage Acceleration Plan. Adding a HELOC into the scheme would have made a trivial difference.
I feel like you’re trying to explain how this scheme works like I don’t understand how it works. I get how it works and don’t need you to explain it to me. It’s works, but it’s not magic. I’m saying it is a relatively minor difference, all else being equal, and it is key to make sure all else is equal.
I was going to write the same spreadsheet, but realized it’s pointless. You have a tremendous assumption regarding the HELOC interest rate in future years. No one knows what the prime rate will be over the next 10-15 years and it significantly impacts the cost/benefit calculations. Maybe you found a fixed rate HELOC, but I definitely haven’t found a worthwhile one.
I don’t know that a fixed rate HELOC is particularly important to doing a mortgage acceleration. Worst case scenario- the HELOC interest rate goes through the roof and you redirect all available investment money at it, pay it off, and don’t take out another one. The HELOC is never supposed to be particularly large. As you pay it down, you pull more money out of it and put it toward the real mortgage.
If you’re going to do this, I think the keys are low fees and a reasonable interest rate on the HELOC, a willingness to have a HELOC instead of a checking account, and a commitment to stay at least cash flow neutral on the HELOC (i.e. not use it as an ATM.) Some additional risk but some benefit for taking that risk. Not crazy, but not magic. Fine to do, fine not to do. No need to be dogmatic about avoiding it, but no reason to expect it to make a dramatic difference. You’re just fiddling around on the edges of your finances.
It’s nice to be debt-free and not have to spend any time thinking about this sort of stuff.
I tried to run the numbers to pay off a 30 yr loan in 10 years with some positive cash flow estimates. This is not even looking at the fees involved. I came out with an estimate of 95% of the benefit comes from pre-paying mortgage principal and 5% of the benefit from the interest arbitrage. A lot simpler to prepay principal when it makes sense. Right now might be one of those times to look at 10 yr expected return of stocks and put some percentage to guaranteed return with no volatility.
That seems about right to me. There’s a benefit there, but it’s not that big and there is some hassle involved.
I would recommend Wells Fargo for HELOCs (there are other things that small banks do much better though!) WF allows you (or at least used to) to do a close to zero closing cost HELOC, however give you a slightly higher variable rate. However you should never use the variable rate, because they will let you draw/advance $10K up to your credit limit, twice per year, and turn it into an fixed interest rate for a year. These Fixed Rate Advances (FRA), have a (1) year term, and generally are priced at the WSJ Prime interest rate MINUS 1-1.5%. I have used several HELOCs on different properties (they also allow investment properties) and borrowed anywhere from 1.99% – 2.99% for the past (5) years. (however with recent rate hikes the FRAs are 3.49% currently). The payments partially amortize (20-30 year schedule) and the remaining balance converts to the variable rate at the end of a year. However if you pay it all down, and then re-draw a new FRA 12 months later, then you can essentially keep the balance fixed in (a year at a time) at low rates (compared to other HELOCs). The one drawback to the strategy WCI described is you can only draw on them once or twice per year, so you can not use them as your “checking account” for debits… However, you can make additional payments as much as you want so each month just move any surplus cash to the payment and you can start working the balance down (or not since the rates are so low, but just find a way to pay off each year, so you can re-draw a new FRA).
I remember this podcast. When he mentioned this product I felt like you wanted to say more, but let it slide. Glad you did a follow up on it because it was crazy to say that you could save 23 years on a mortgage by doing this one thing.
Yeah, that math makes my head hurt. I’ll stick to sending in extra monthly payments (equals about 2 extra months yearly) on our 15year.
I’ve spent the last year trying to decide when I should aggressively pay off my mortgage. I max out all tax advantaged space and put the equivalent in taxable accts each year. Wondering if I should direct some of that money to my mortgage. I’ve had a mindset to reach my number first then pay off mortgage. Not sure if that’s a good idea
I don’t think there is a wrong answer, at least prospectively. Obviously in retrospect there will be.
What is the interest rate? If the rate is low (below 4%) then it isn’t as important to accelerate payments.
My interest rate is 3.25 percent. The goal is to reach my number which I’m half way there and to pay off my mortgage so I have an option to early retire. I need to decide whether I want to reach my number first, then attack the mortgage or focus on paying off my mortgage which I think I could do in about 7 to 8 yrs, maybe sooner.
I was making close to minimum wage, but was able to secure NINJA loan for $250K in Arizona in 2004. I even refinanced the house and took out 120K, but lost my job in 2009, and lost my house. In 2011, I (my wife) was able to buy a better house o the same block for $115K. Now, I would love to listen to a PODCAST on how I can do this again.
An excellent reminder of the risks of leverage.
Another option to accelerate your mortgage is to use the “100% down” payment method.
That would accelerate it all right. There is a bit of a disconnect between someone who wants to be out of debt enough to accelerate their mortgage and someone who takes out a HELOC isn’t there?
This product reminds me of all my “smart” friends shuffling balances between zero interest credit cards while explaining the brilliance of their financial strategy. My only response was always “I don’t carry credit card balances, but am happy that it’s working out for you”.
I first heard about this type of financial wizardry about ten years ago. It was (intentionally) incomprehensible despite being intrigued enough to sit through an hour long sales presentation hoping to actually understand how it worked. That understanding never came. Thanks for the far simpler explanation, WCI.
Additional downsides:
– it’s not possible for any HELOC to be less expensive than an equivalent well-shopped mortgage because it’s always in 2nd place which entails more risk for the lender. The only way of offsetting that risk is with higher fees regardless of how well hidden they may be with variable rates, zero cost setup, free appraisal, etc. The lender knows its borrower profile and spending habits far better than the typical borrower knows themselves.
– variable rate financing of any kind is inherently riskier than fixed rate
– you have ZERO cash on hand at all times. Accessing borrowed funds is not remotely like having cash, nor is seeing a lower balance after automatically depositing your paycheck each month.
– making HELOC interest non-deductible significantly reduces the potential value of the wand waving
Our 2.75% 15 year mortgage works fine for our purposes. Only one moving part involved.
I would expect most regulars on this site already have or could easily find similar financing.