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Our goal is to make sure our clients (as well as perpetual information seekers) are well educated. You'll find The Shred Method™ Blog to be a mix of articles about financial literacy, infinite banking, investing, crypto, and a host of other topics related to our way of managing cash flow. If you're curious about thinking differently, you've come to the right place. We're contrarian in all the right ways.

The Power of a Heloc

May 30, 2022

Home Equity Lines of Credit have long been sold as just another spending tool. You’ll see ads for HELOCs used to buy 4-wheelers and boats, paying for a new roof or a wedding, sometimes even that family vacation. All of these are ultimately just about spending more. Going deeper into debt. Owning less and less of your income. 

However, the HELOC is a much more powerful tool than most of us realize. 

When used as a “sweep account” of sorts for your income, the HELOC becomes one of the most powerful debt elimination, mortgage acceleration tools ever designed. 

Would you pay $5 in simple interest to borrow $100, if you knew the $100 would save you $2,000?

This question has been asked of hundreds of audiences and they all come back with the same answer, “every day of the week”. 

And in the same breath, the very same audiences have been asked the question, “how many of you have a HELOC?” And a wide swath of those very same audiences have no idea what a HELOC is. 

The best way to describe a HELOC, as compared to a traditional mortgage, is a HELOC is a Two-Way Street, where a traditional mortgage is a One-Way Street. 

When you make a mortgage payment, the lender takes your payment in, applies a large amount to interest and a smaller amount to principal. (You’ll learn how the interest is calculated in a moment.) When the payment is accepted, there is NO WAY to get that payment back out unless you either sell the home or refinance the mortgage and take cash-out (which would cost you thousands of dollars and reset the mortgage amortization schedule back to payment one).

However, with a HELOC, because it functions as a two-way street, you can easily put money in AND take money out. 

Where most consumers with a HELOC make a small monthly payment, just like they would with any other debt, savvy Shredders know that every time they deposit their income in the HELOC it lowers the average daily balance of the debt, thereby reducing the amount of interest charged. When they need to access more money, they simply pull it from the HELOC and repeat the two-way street process all over again. 

How interest is charged is the important part. 

Mortgage interest is calculated based on the amount owed on the last day of the previous month. So, if you owed $400,000 on your mortgage at the end of the month, and your interest rate was 4%, the calculation would look like this:

($400,000 x 4%) / 12 = $1,333.33 

For that month, you would owe $1,333.33 in interest. If your payment was $2,000, then the remaining $666.67 would go to principal.

So, at the end of the next month, your balance on the mortgage would be $399,333.33

and the interest calculation would look like this:

($399,333.33 x 4%) / 12 = $1,331.11

HELOC INTEREST IS DIFFERENT

Your HELOC interest is calculated based on the average daily balance, NOT on the ending balance on the last day of the month. So here is the power of that — let’s suppose that we’re going to borrow $5,000 from the HELOC and pay down the primary mortgage. 

That $5,000 is only going to sit in the account for about 10 days or so before your paycheck drops into the account and brings the balance down. So, interest would be charged on the full $5,000, but instead on an average daily balance of $2700. 

Let’s say that the interest amount on the HELOC is 5%. (You can see that it’s MORE than the mortgage and that’s perfectly fine.)

The interest calculation would look like this:

$2700 X .00013699 X 30 = $11.0

The numbers above are: 

$2700 — average daily balance

.00013699 — .5% divided by 365 days

30 — number of days in the month

Now remember when you were asked would you pay $5 in simple interest to borrow $100 if it saved you $2000?

Well, would you pay $11 in simple interest to borrow $5,000 if it would save you $11,700 in interest?

Because here’s what happened — when we drop the $5,000 on the mortgage balance of $400,000, it drops the amount owed to $395,000. You wouldn’t have gotten to that balance until 9 payments later. When the average amount of the interest payment is $1300, x 9 payments, that equals… $11,700. 

And THAT is the power of the HELOC. 

By the way, it’s oh so much more, but we save a lot of that for The Shred Method™ course. 

Download the free HELOC Guide

Is your mind blown yet?

If not, read THIS.