Tuesday, July 23, 2024
Introduction to Using a HELOC for Mortgage Payoff
The concept of using a Home Equity Line of Credit (HELOC) to pay off your mortgage faster, often as early as within 5 to 7 years, has gained popularity. This method, part of the Velocity Banking or the Accelerated Banking strategy, involves using a HELOC to make large payments towards your mortgage principal, thereby reducing the amount of interest paid over time. However, many wonder how the HELOC itself gets paid down. In this blog, we will unpack how the strategy works and why it’s effective. Now keep in mind that this strategy may not even work for some homeowners. It’s important for you to carefully review the strategy to understand the risks before implementing it.
Understanding Cash Flow and HELOC Repayment
The straightforward answer to how the HELOC gets paid off is through cash flow. Cash flow is calculated by subtracting your total expenses from your net income. For example, if you make $10,000 a month and have $8,000 in expenses, your cash flow is $2,000. This $2,000 is then used to pay down the HELOC balance.
Here’s a breakdown of the process:
1.0 Income and Expenses: Calculate your total monthly income and expenses.
2.0 Cash Flow: Determine your cash flow by subtracting expenses from income.
3.0 HELOC Payments: Use the remaining cash flow to make payments towards the HELOC balance.
Why Use a HELOC Instead of Direct Mortgage Payments?
One might ask why not just use the extra $2,000 to pay directly towards the mortgage instead of through a HELOC. The answer lies in the way interest is calculated on a HELOC versus a traditional mortgage.
The Importance of Daily Balance and Interest Calculation
HELOCs calculate interest on a daily basis. By making payments towards the HELOC balance, you can lower the daily interest charges significantly. For instance, if you have a $10,000 balance on a HELOC with a 6% interest rate, the daily interest is about $1.64. If you make a $1,000 payment towards the HELOC, the balance drops to $9,000, reducing the daily interest to $1.47.
Consider the following scenario to understand the impact of using a HELOC:
Initial HELOC Balance: $10,000
Interest Rate: 6%
Daily Interest Calculation:
$10,000 x 6% / 365 = $1.64 per day
If you make a $5,000 payment towards the HELOC from your income, the balance drops to $5,000:
New Daily Interest: $5,000 x 6% / 365 = $0.82 per day
This reduction in daily interest adds up significantly over time.
Maximizing Savings with a Credit Card
To further optimize this strategy, use a credit card for your daily expenses and pay off the credit card balance with the HELOC at the end of the billing cycle. This approach delays the accrual of interest on the HELOC and takes advantage of the interest-free period offered by credit cards.
Visualizing the Impact
Using visual aids can help clarify how this strategy saves money. For example, a calendar can illustrate how daily balances and interest charges change throughout the month based on your transactions. This visualization can demonstrate how making a $5,000 HELOC payment early in the month reduces interest charges for the rest of the month.
Conclusion
Using a HELOC to pay off your mortgage faster leverages the daily interest calculation to your advantage, resulting in significant savings over time. By integrating cash flow management and strategic use of credit cards, you can reduce your mortgage term and interest payments effectively.
For more detailed information and personalized advice, consider consulting with a financial advisor. If you have any questions or need further clarification, feel free to leave a comment, and we will respond as soon as possible.
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