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

[roastbeef]

i listen to a few podcasts on passive income and dabble in real estate a little bit, but i'm still an amateur, and i'm definitely not a math guy.

a recent podcast highlights jordan goodman's suggested strategies of "debt optimization." basically, you use a heloc to pay towards your primary residence principal debt and effectively use the heloc as a checking account to flip the amortization schedule around to front load the principal payment as opposed to the interest payment.
this is a link to the podcast transcription where the below text is clipped from;

http://www.passiverealestateinvestin...o-seven-years/

"I’m here in Southern California. Let’s just say someone has a $500,000 mortgage and they go out and get a $100,000 HELOC.

They’re owing $600,000 and the house is worth $800,000, whatever it may be. Let’s say you’ve got $500,000 first and you took out a $100,000 second. Your $500,000 first is really good, 3.5% very, very low interest rate. Here’s how you’re going to do it. I’m actually going to take you step by step how this whole thing would work. You’ve got your first $500,000, 3.5% rate mortgage. You take out the HELOC for $100,000 and then it’s now, as you said, free and clear. You just open the thing up. You write a check on the $100,000 HELOC towards your first. You haven’t added any debt, you just shifted part of it from the first to the second. You still owe $500,000 total. You just owe $400,000 in the first and $100,000 in the HELOC.

You use the HELOC on which you owe $100,000 as your checking account. I’m just going to do an oversimplified example. Say you had $1,000 that you just got in the paycheck, normally you’d be keeping it in the checking account. You get paid. It goes in your checking account. You electronically transfer it to your HELOC. Instead of owing $100,000, you now owe $99,000. You just pay it down by $1,000 for that day. The HELOC company takes a look and says, “Yesterday, we charged him interest on $100,000. Today, we’re going to charge him interest on $99,000.” Your interest goes down a little bit because you owe less principal. That’s happening during the month. All the income you’ve got is going to that HELOC, pushing the principal down at a regular basis. Then you pay your bills out of the HELOC. Your balance is going down, down, down, down. One day a month it goes up when you pay your bills. The best way to do this is actually have all your bills charged on one credit card; your utility bills, your food bills, all the bills on one credit card. Basically, you pay one bill a month is where it comes down to. Every day during the month, you’re making progress in your principal and the one day a month when that credit card bill is due, you pay the credit card electronically and your balance is going to go up by the amount of the credit card. Your money is working for you every day pushing that principal down.

The next month is the same thing. You keep adding $1,000, you keep adding whatever income’s coming in, get all that money pushing down that principal every day. In six months, nine months, however the numbers work out, you will have paid off that $100,000 HELOC down to zero. You still owe $400,000 or maybe even less than $400,000 on your first. Remember, you haven’t made hardly any progress at all on that. You do it again. You write another check on the HELOC for $100,000 towards the first. Instead of owing $400,000, you owe $300,000. You do the same thing, you pay the HELOC off of your six months, nine months, however long it takes. Do it again, you’re down to $200,000. Do it again, $100,000. Do it again, your first is now paid off. You pay off the HELOC. Depending on how the numbers work, five, six, seven years, you’re completely debt-free.

You see how your money is working for you instead of the bank? Your checking account is pretty much zero. Your mortgage balance is going down at an accelerating rate and your HELOC is going down at an accelerating rate because all your money is working for you every day pushing down that principal. The way I like to put it, instead of having your money in a checking account not earning interest, your money is in the HELOC not paying interest. Does that make sense?"

anyone still reading and have thoughts?

[2000cs]

You didn’t pay any interest on the HELOC. That rate is typically higher than the first mortgage. And deductibility of the HELOC interest is unlikely.

Most mortgages allow you to make extra payments to principal, so why not just do that? In both cases your payments don’t decline because the first doesn’t adjust unless you do a refi. So I’m not seeing an advantage to using the HELOC.

Couple of disadvantages would be it has to lower your credit score and it unnecessarily uses debt capacity. If you have a good investment that you are funding with the HELOC, it could make sense I suppose.

Would like to hear others’ opinions.

[Lucky John]

It is an interesting concept and would require review with your accountant to see how your taxes would affect things. It might provide a slight advantage with the right conditions and provisos-i.e. you can't run around spending heloc money on cars and trips which is what would probably happen.

That said, "Depending on how the numbers work, five, six, seven years, you’re completely debt-free." Yeah right. Basically that assumes you are paying off the heloc in one year. Take 100,000 and divide by twelve. You are paying about $8,000 extra a month on the heloc. Probably not going to happen. Additionally if you have an extra 8k a month to invest I can think of other things you could put the money into. Any 457 401k that shields the money from taxation would be the place to start.

[XKxRome0ox]

earlier in the year i stopped by a few banks to inquire about getting a HELOC
i was going to use the HELOC to pay off my student loans and then pay back the HELOC with what i'm normally paying to the student loans
because i was assuming the HELOC would be significantly lower rate than my student loans (i have several loans that are at approx. 2.75%, 3.75%, 4.75%, and 6.7% something like that)

i don't remember the exact numbers but i know it wasn't low enough to really make a difference
the HELOC was going to be like 4.25% and higher? yea it's lower than my 6.7% loan but my total balance for that particular rate wasn't that high
so in the end decided it wasn't really worth taking out the loan

and interest rates have gone up since then... for both HELOC and my student loans


i'm surprised the OT on this forum doesn't have a "finance" or "money talk" subforum

[roastbeef]

Originally Posted by Lucky John

It is an interesting concept and would require review with your accountant to see how your taxes would affect things. It might provide a slight advantage with the right conditions and provisos-i.e. you can't run around spending heloc money on cars and trips which is what would probably happen.

That said, "Depending on how the numbers work, five, six, seven years, you’re completely debt-free." Yeah right. Basically that assumes you are paying off the heloc in one year. Take 100,000 and divide by twelve. You are paying about $8,000 extra a month on the heloc. Probably not going to happen. Additionally if you have an extra 8k a month to invest I can think of other things you could put the money into. Any 457 401k that shields the money from taxation would be the place to start.

right. this is where i get "lost" on the subject. i want to say the scenario assumes you're in a mortgage you can afford and qualify for with your income... no magic money. there seems to be an unexplained gap there.

as for taxes, my wife and i are bracing for a not-so-great tax year. we aren't wealthy, but my current primary is financed at 3.25% for 20 years (18 years left) at $335k. it doesn't take much income to overtake the tax benefits.

[roastbeef]

Originally Posted by sansin

interesting. HELOC likely has a higher rate, and variable, so you probably want to pay it down quickly... but you offset with interest otherwise paid on the mortgage. Are restrictions placed on HELOCs? Can you use them to refi other debt or are there restrictions?

The argument is that the savings of reducing interest from a 30 year amortization overtakes the HELOC interest cost, even if it is significantly higher.

[roastbeef]

By the way, I'm not arguing that this is a good idea. I'm developing a basic understanding of the concept, but I'm not familiar with how HELOCs are calculated. I've been playing with calculators, but there isn't anything like this.

[dreamingat30fps]

I read the whole thing, I don't get it. Whats the difference between that very complicated system and simply paying extra on your mortgage? If you have the income to pay off the $100k HELOC in a year why couldn't you just put that $100k you have been paying towards the HELOC towards your primary?

[TheHouseWon]

The money is working for the bank, not you (they earn interest on HELOC and mortgage).

If you have cash you can pay down your mortgage (very conservative investment) or you can buy mutual funds of varying risk (moderate to aggressive investment).

[DETRoadster]

This totally lost me. Maybe with the perfect economic conditions this could work but as others have said, HELOCs are typically at higher rates and variable. My "If it seems too good to be true it probably is" alarm is going off...

Kind of reminds me of a really complex version of the debt shell game a former co-worker of mine used to play where he'd take out a new credit card and use the "No payment for 90 days on balance transfers" introductory offer to pay off his other card. He just kept dong that over and over for a couple years. Racking up debt and never paying it off. He finally declared bankruptcy and started all over. Dumb ass.

[dreamingat30fps]

I found this video and I think this guy explained the concept pretty well. I get it now, however seems like more trouble than it's worth, plus a lot of what ifs that could mess up the whole thing. You also need to have enough cash laying around to offset the higher rate of the HELOC.

I like simple. I keep enough cash on hand to deal with any emergencies that may arise. I invest the rest in mutual funds and pay as much extra on my mortgage as I can every month. Sleep like a baby.

[roastbeef]

what is interesting is you do have cash on hand- the heloc is liquid until it transitions out of the draw period (you're supposed to pay it off during the draw period in this technique).

you are essentially becoming your own banker with the equity in your home. you don't have money in bank accounts- you use all your money to pay down your heloc. you also pay your bills out of your heloc. thats how you maximize every possible cent to pay down the heloc.
where i get lost is in the math. there is different ways to calculate interest amongst these loans. and somehow, it is supposed to work well without an increase of income.

[TheWatchGuy]

seems like a good way to screw yourself if rates take a decent hike.

if a guy that obviously understands it and knows how it works isnt doing it (guy in that youtube video), that should tell you something.

Also, if you are able to pay off 100k in a year on a heloc, you should be able to pay off 100k of your mortgage in that same period.

Edit: Just checked with my mortgage company online to see what their HELOC rates are, and they are significantly higher than what my mortgage is.

[xander_g]

The biggest variable here is the interest rate. Generally, people would get a heloc to pay down credit cards as the interest rate is lower. if you have some solid short term investments lined up, it would be a good idea as the money would be working for you and not the bank.

[Run Silent]

Originally Posted by xander_g

The biggest variable here is the interest rate. Generally, people would get a heloc to pay down credit cards as the interest rate is lower. if you have some solid short term investments lined up, it would be a good idea as the money would be working for you and not the bank.

The big issues with this are as follows:

1) Borrowing money on your home to pay down unsecured debt is generally not a good idea, as it transfers the risk from the CC to an asset that can be revoked should you default. Stop paying a CC and you have a credit score dump. Stop paying a HELOC or Mortgage and you become homeless.

2) This system fails to take into account the calculations for risk. If we abide by this strategy, we would all just refi our homes for the maximum amount and then use that money to go invest in the market. We don't do that, because there is risk involved - something that this doesn't seem to account for.

3) HELOC's are nearly always a variable rate. Current trends are assuming rates will continue to rise in the near term. Those rising interest rates on the HELOC would likely negate any gains you might be able to achieve.

4) Someone who has loads of credit card debt typically doesn't have a good track record of sound fiscal decisions. The chance of that person diligently paying the CC's off with the HELOC and then using tons of cash to pay off the HELOC is doubtful, as someone that responsible and careful with their money probably wouldn't have a large CC balance that they couldn't pay off monthly to begin with.

5) Keep in mind that HELOCs have the same upfront costs as a mortgage, including documentation fees, appraisal fees, credit check fees, third-party fees, etc. But once you get the offer, you’ll need to agree on the terms, which can vary. This is where you’ll really need to pay attention.

6) Another very important thing to know about how a HELOC works is that when your credit term expires, the balance must be paid in full. The same is true if you sell your home. And even if the loan doesn’t expire, the bank can freeze your credit line if the value of your home declines below its appraised value. In all three of these fine-print scenarios, you could find yourself in a tight (even critical) financial spot—especially if you’re carrying a high HELOC balance.

[xander_g]

Originally Posted by usshelena725

The big issues with this are as follows:

1) Borrowing money on your home to pay down unsecured debt is generally not a good idea, as it transfers the risk from the CC to an asset that can be revoked should you default. Stop paying a CC and you have a credit score dump. Stop paying a HELOC or Mortgage and you become homeless.

2) This system fails to take into account the calculations for risk. If we abide by this strategy, we would all just refi our homes for the maximum amount and then use that money to go invest in the market. We don't do that, because there is risk involved - something that this doesn't seem to account for.

3) HELOC's are nearly always a variable rate. Current trends are assuming rates will continue to rise in the near term. Those rising interest rates on the HELOC would likely negate any gains you might be able to achieve.

4) Someone who has loads of credit card debt typically doesn't have a good track record of sound fiscal decisions. The chance of that person diligently paying the CC's off with the HELOC and then using tons of cash to pay off the HELOC is doubtful, as someone that responsible and careful with their money probably wouldn't have a large CC balance that they couldn't pay off monthly to begin with.

5) Keep in mind that HELOCs have the same upfront costs as a mortgage, including documentation fees, appraisal fees, credit check fees, third-party fees, etc. But once you get the offer, you’ll need to agree on the terms, which can vary. This is where you’ll really need to pay attention.

6) Another very important thing to know about how a HELOC works is that when your credit term expires, the balance must be paid in full. The same is true if you sell your home. And even if the loan doesn’t expire, the bank can freeze your credit line if the value of your home declines below its appraised value. In all three of these fine-print scenarios, you could find yourself in a tight (even critical) financial spot—especially if you’re carrying a high HELOC balance.

I'm with you on all of that, but I have used a heloc in the past to pay off cc's and then quickly paid off the heloc, at the time and given the situation it was the optimal solution.

And I really agree with you on the risk part, I know someone who would refi the mortgage and then use that as a downpayment on another property and then the market took a shit.... im sure you can guess how the rest of that story went. The scary part is, there are a lot of people in similar situations out there so if shtf, a domino effect happens.

[Hawkeye]

Originally Posted by roastbeef

The argument is that the savings of reducing interest from a 30 year amortization overtakes the HELOC interest cost, even if it is significantly higher.

This does not make sense. If the interest rate is higher, you are better off leaving it in the original mortgage and just paying the mortgage as you are saying you would pay the HELOC off.

[TheHouseWon]

This "strategy" benefits banks, brokers, accountants, etc more than the end-user. Just FYI

[B58 parts]

I used a PLOC to get rid of my consumer debt. It was a good strategy for me, but it's not for everyone. Lot of things to keep straight. Most people get hung up on interest figures. That's not really what it's all about, it's about eliminating payments sooner and increasing cash flow.

I got rid of 15k debt in 7 months by parking my income against it. My local bank made 180 for the loc. I saved over 1600 in interest costs. And I am now 600 a month richer. No debt, closed accounts, title for the car in hand. Could I have saved that 180 paying manually yes, but who cares it's already over and I'd still have the accounts open that way.

I am uncertain if a secured HELOC is a good idea for me. But the unsecured PLOC was a good move to get my disposable income up quickly. I don't like the idea of losing the house .. variable rate is more dangerous when combined with a long period of time..

[Matt@EuroJerks]

Originally Posted by YuminNuman

I used a PLOC to get rid of my consumer debt. It was a good strategy for me, but it's not for everyone. Lot of things to keep straight. Most people get hung up on interest figures. That's not really what it's all about, it's about eliminating payments sooner and increasing cash flow.

I got rid of 15k debt in 7 months by parking my income against it. My local bank made 180 for the loc. I saved over 1600 in interest costs. And I am now 600 a month richer. No debt, closed accounts, title for the car in hand. Could I have saved that 180 paying manually yes, but who cares it's already over and I'd still have the accounts open that way.

I am uncertain if a secured HELOC is a good idea for me. But the unsecured PLOC was a good move to get my disposable income up quickly. I don't like the idea of losing the house .. variable rate is more dangerous when combined with a long period of time..

What does the highlighted portion mean?
What were you paying off?

[zx10guy]

Originally Posted by Hawkeye

This does not make sense. If the interest rate is higher, you are better off leaving it in the original mortgage and just paying the mortgage as you are saying you would pay the HELOC off.

Plus I would say most people are able to write off the interest payments made on their primary mortgage. Going forward HELOC interest is not tax deductible.

[Hawkeye]

Originally Posted by Matt@EuroJerks

What does the highlighted portion mean?
What were you paying off?

If I understand the strategy, it is for people who are bad at managing their money in the first place.

He has 15k of debt (CC, high interest loan, etc) and through a PLOC he is able to put 100% of his income towards the payments without having to worry about not having money to pay normal bills.

To me, I would rather just use my crude excel spreadsheet to track my income and payments and just pay the excess income towards the loans without opening a HELOC or PLOC.

This seems like a Dave Ramsey-ish approach. There is definitely a better way to do it, but this one is more "fool proof".