HELOC to Pay Off Your Mortgage… Why Does it Work? When it comes to paying off a mortgage, homeowners often feel like they’re locked into decades of fixed payments, with a significant portion of each installment being swallowed up by interest. However, there’s a strategy that can change this narrative: using a Home Equity Line of Credit (HELOC) to accelerate mortgage payoff. The concept isn’t new, but understanding why it works is crucial for those looking to reduce their interest payments and shorten their loan term.
A HELOC is a revolving credit line that allows you to borrow against the equity of your home, typically at a lower interest rate than other credit forms. The reason it can be an effective tool in paying off a mortgage lies in the way interest is calculated and how payments are applied to the loan balance.
Let’s delve into the mechanics using two illustrative examples. Suppose you have a mortgage balance of $10,000 at a 6% interest rate. In the traditional mortgage setup, interest accrues on the outstanding balance, leading to a significant amount of your payment going towards interest, especially in the early years.
Now, introduce a HELOC into the scenario. In our first image, we see a daily interest calculation on the full $10,000 balance, resulting in a $1.64 charge per day. By the end of the month, this adds up to $49.20 in interest. However, when you make a substantial principal payment, such as $1,000, the daily interest drops in the subsequent days. This payment reduces the principal balance upon which daily interest is calculated, thereby decreasing the overall interest charges.
The second image illustrates why and how Accelerated Banking works. A large principal payment of $5,000 is made to simulate the user’s income being deposited into the HELOC. Then on the 28th day of this hypothetical month, a $4,000 withdrawal is made to simulate the users’ monthly expense. Here, the daily interest charges are halved to $0.82 due to the reduced balance after taking the user’s income and depositing it into the HELOC balance. However, because of the revolving nature of the HELOC, the user is able to draw $4,000 out of the HELOC to pay of their monthly expenses. To add further, the user may want to use a credit card to pay for everyday purchases to delay the draw from the HELOC since interests aren’t accrued immediately on credit card purchases. While the “net” payment on the HELOC is still $1,000 – the total interest at the end of the month is only $26.55, a significant saving compared to the first scenario.
Some may simply dismiss the Accelerated Banking strategy as a “shell game” but the math behind the Accelerated Banking strategy proves it to be more beneficial. Some may only see the similarities of both scenarios where the ending balance has decreased by $1,000. But they fail to see the effects on the daily interest calculation and how it can be used to save money.
This principle of daily interest calculation is at the heart of why using a HELOC to pay off your mortgage can be beneficial. When you deposit your paycheck into the HELOC, you’re effectively reducing the daily balance, which is used to calculate the interest. By keeping the balance as low as possible for as long as possible, you minimize the interest accrued.
Moreover, because a HELOC is a revolving credit line, you can withdraw funds as needed up to the credit limit, allowing flexibility in managing your cash flow. You can make large payments toward your mortgage when you have the funds and then draw from the HELOC for necessary expenses. This flexibility is what makes the strategy workable for many households.
It’s also worth noting that a HELOC does not restrict you to a rigid payment schedule like a traditional mortgage. This means that any extra income you earn can immediately be put to work reducing your debt, rather than waiting until the next scheduled mortgage payment.
Using a HELOC to pay off your mortgage can be an incredibly efficient strategy, but it’s not without its caveats. It requires financial discipline to ensure that the money saved on interest doesn’t get spent elsewhere. It also necessitates a stable income, as you are borrowing against your home’s equity, which requires careful financial management.
In conclusion, a HELOC can be a powerful tool in your mortgage repayment strategy. By leveraging the lower interest rates and the flexibility of payments, you can significantly reduce the total interest paid and potentially shave years off your mortgage. The daily interest calculation images clearly demonstrate how consistent, substantial payments towards the principal can result in less interest over time, proving the effectiveness of the HELOC strategy in mortgage repayment.