Mortgage guys, lenders, money guys, mathematicians - lets talk about this HELOC plan

[B58 parts]

You're right .. for most it's probably better just to determine what's disposable and send that against the debt. But, once you send that, it's sent, you're not getting it back. The LOC is revolving so it gives you a 'take back' if for some reason you wanted it.

The other difference is you're no longer liable for the monthly payments to the loan on schedule and the payments to the LOC happen automatically when you transfer your income to it. And the interest on the LOC is 'average daily balance', so the act of parking the income against it throughout the month drives the interest cost down, as opposed to letting those funds sit in your checking/savings until they are 'ready' to send against the debt. Effectively every dollar you have is working against the debt every day of the month, and at the end of the cycle everything you didn't spend (or want to leave in there) is against it (and you can pull it back if you want). V.s. calculating that out and sending forever. So it's a way to pay off a debt as quick as you want, or don't want.

It's nice to be debt free. I'm never borrowing again...

[F32Fleet]

IMO the key to this approach is having sufficient cash flow to pay off the HELOC couple of years. For example 5 yrs would be $1,666/mo on top of your monthly debt payments.

It also looks like you gain "double-deductibilty" of mortgage interest. You get an additional bump in mortgage interest deduction because the balance used to calculate the interest for the monthly HELOC payment includes the monthly interest portion of the monthly payments you're making on the existing first mortgage. Of course we all know that there's a limit to how much interest one can deduct before the AMT kicks in.


Interest on HELOC is calculated off the daily balance and the rate is always some index (i.e. WSJ Prime rate from previous month) plus margin (1,2,3% etc).

[tdott]

This works if you have cash in places not earning much interest (lower than your mortgage rate) and earn a fair bit more than your monthly expenses and you plan to throw every spare penny you have into paying off your mortgage.

It's a decent strategy with low risk.

But it's possible to do better if you take on more risk, instead of throwing everything you have at your mortgage (with low intereste paying only 3-5%), instead lets say you save 100k. Instead of paying off 100k of your mortgage, you can invest it and possibly earn 5-10% (mutal funds, etf, stocks, etc) . But that comes with risk, and you could possibly loose some/all of your investment. But you could be better off in the good economy than simply just saving your mortgage interest.

One advantage of this depending on your tax situation, you should be able to deduct your mortgage interest (upto 750k mortgages in 2018), reducing your taxable income and if your growing your retirement portfolio in a tax sheltered instrument (ISA, 401k, etc), your deferring your tax burden (contributions lower your taxable income now) and that investment grows tax free until you withdraw when you retire (hopefully at a lower rate when you retire and withdraw when you have a lower income than you make now) or taxable at a lower rate depending on the investment.

The options are pretty much endless assuming you are cash flow positive. If you can't pay your current bills and live beyond your means, no strategy is going to help you without reducing your spending/expenses.

Now if you think a recession is coming and you will be hard pressed to earn 5-10%+ on your investments, you should be moving all of your investments into low risk areas, or staying liquid or paying off your mortgage could be good idea.

[tdott]

Originally Posted by F32Fleet

It also looks like you gain "double-deductibilty" of mortgage interest.

Sorry, I don't understand this part. If you are paying less interest overall, wouldn't that reduce any advantage?

Plus I believe with 2018 tax changes, there are some cases now when HELOC interest is no longer tax deductible. "If you plan on taking this deduction, your loan must be used to “buy, build or substantially improve” the residence that secures the underlying loan." is how I understand it, but i'm not 100% sure how it will play out.

[F32Fleet]

Originally Posted by tdott

Sorry, I don't understand this part. If you are paying less interest overall, wouldn't that reduce any advantage?

Plus I believe with 2018 tax changes, there are some cases now when HELOC interest is no longer tax deductible. "If you plan on taking this deduction, your loan must be used to “buy, build or substantially improve” the residence that secures the underlying loan." is how I understand it, but i'm not 100% sure how it will play out.

You may pay less interest overall on the mtg but the scheme says you use the HELOC for all of your expenses (ie turn it into your checking account). I can only assume the proponent is assuming you take all of the interest as a deduction. I'm not familiar with the 2018 tax changes but if it's what you say it is will make the scheme for not unless you want to role the dice over a potential audit.

In any case here's what I was talking about.,

1st mtg is $1000/mo of which $500 is interest.

HELOC used to make the $1000 payment and monthly payments on the HELOC (higher rate) contain interest ($100) if you didn't pay the mtg payment with the HELOC then your monthly interest paid on the HELOC might only be $90.

Write off: $500 interest on 1st mtg and $100 interest on HELOC for total $600 vs $590. You gain an extra $10/mo in tax deductible interest.

[tdott]

Originally Posted by F32Fleet

Write off: $500 interest on 1st mtg and $100 interest on HELOC for total $600 vs $590. You gain an extra $10/mo in tax deductible interest.

I guess it would be situation dependent. If you are adding debt then sure you'll pay more interest. In the example the OP gave, you are using the 100k HELOC to payoff the mortgage 100k then you payoff the heloc as fast as you can. So the mortgage payment/interest would be less, then as you pay off the HELOC that interest should be less over the same period (since that is the goal, to pay down the heloc and as a result reduced interest) than what you would have paid if that debt was in your mortgage is what I was thinking.

[zx10guy]

Originally Posted by F32Fleet

IMO the key to this approach is having sufficient cash flow to pay off the HELOC couple of years. For example 5 yrs would be $1,666/mo on top of your monthly debt payments.

It also looks like you gain "double-deductibilty" of mortgage interest. You get an additional bump in mortgage interest deduction because the balance used to calculate the interest for the monthly HELOC payment includes the monthly interest portion of the monthly payments you're making on the existing first mortgage. Of course we all know that there's a limit to how much interest one can deduct before the AMT kicks in.


Interest on HELOC is calculated off the daily balance and the rate is always some index (i.e. WSJ Prime rate from previous month) plus margin (1,2,3% etc).

You might want to read this:

https://www.irs.gov/newsroom/interes...-under-new-law

As it applies to this discussion about using a HELOC to help consolidate existing debt, you won't be able to deduct the interest payments.

[F32Fleet]

Originally Posted by zx10guy

You might want to read this:

https://www.irs.gov/newsroom/interes...-under-new-law

As it applies to this discussion about using a HELOC to help consolidate existing debt, you won't be able to deduct the interest payments.

Ya we were talking about that up top.