Dumb question, and mainly a reflection of my own pea-sized brain at this point.
Honest questions are not dumb.
1) your regular mortgage is compounded monthly
Both are compounded at least monthly.
2) your heloc would be compounded daily..Coupled with a direct deposit of paychecks say at bi-weekly intervals, the running balance on the heloc would be lower such that despite the higher interest rate and higher frequency of compounding,..
It would seem so, but unfortunately there is a fly in the ointment. What if I have no HELOC and just pay the mortgage like normal. Since I am not carrying any balance for any period on the HELOC… I get no charges on the HELOC. Compare that with a 15 day charge at X% for 1 mortgage payment and 15 day charge at X% for 1/2 mortgage payment… The non HELOC wins.
This discussion was originally about the software so lets quickly deal with that. The methodology for making the payment structures I am about to mention is actually quite simple. The problem with the software is that, because of its cost, it puts you at least a month behind on payments (charged to HELOC). Effectively it charges you for something you can do with pen and paper. If the cost of the software was under $100, it might be worth the convenience. Unfortunately the cost is something like $3500(At last I heard/saw mentioned). The other problem may be that this application expects you to use an HELOC from a certain supplier. I saw mentioned of a peak HELOC rate mentioned earlier of 21% (search down for 21, it is the 15th paragraph). This is a very high rate for a credit card (unsecured credit). For a HELOC or mortgage, which is a secured loan, it is downright usurious.
Now for the underlying technique:
I am not going to call this a program or anything else because people have been using this technique for years to reduce debt costs. It is based upon using cheaper money to pay off more expensive money. It is much like shifting balances to cards with cheaper rates. The only difference in this case is that you have added an HELOC as a credit option. Right off the bat, this requires discipline, and no software package will help you with that!! I am not going to address using HELOC money for investment instead of buying on margin right now (complicates the discussion)
Some basic facts:
1) Credit card debt is more expensive (other than the teaser rates) than HELOC or mortgage debt (cost of this money is generally the highest).
2) HELOC and mortgage interest is deductible unless you are taking large capital gains or have other deductions that push you into AMT (Alternate Minimum Tax).
3) The fact that HELOC and mortgage interest is deductible reduces their effective rate considerably. If a mortgage rate is 6% and you are in a 33% marginal tax rate bracket, the effect rate on the mortgage is 4% with deductions taken into account. (Marginal tax rate is % of each additional dollar that goes to taxes. This is not calculated by dividing total taxes by taxable income. You use the tax formulas at the end of 540 and 1040 and add up the percentages that are shown until you are in your income bracket.)
The basic method breaks down into sorting all of your debts(including credit cards) by their tax adjusted interest rates. Allocate out of your monthly salary, the money to pay the minimum amount on each debt. Now, with the remainder, commit the balance of the funds to pay down the debt with the highest tax adjusted interest rate (point of why we sorted them). Normally the cheapest credit card is used to pay for that months expenses (some credit cards give 1 one month interest free grace period on charges accrued during the month). This is where the HELOC becomes useful, and discipline is required. Because HELOCs have a lower effective tax adjusted interest rate than just about any credit card, you can use HELOC money to pay down the cards and effectively use cheaper money. The discipline is in not racking up charges on the card afterwards and keeping your net expenditure, include debt service, lower than your income. You don’t want the balance on the HELOC to grow. Some HELOCs allow you to write a check/use a debit card against them directly, so they can be used almost like a credit card. The other advantage of the HELOC is that it can absorb the shock of a big expenditure better than a credit card. This also allows you to commit more of your cash to paying off the debt instead of having it sit in a checking account.
When it comes to investing, it makes the whole thing above ‘topsy turvy’. Debt allows you to have a higher return on assets (note that I did not say equity). You are using someone elses money to get a return on your investing activity. The only problem is that it introduces risk and on the downstroke (if your return is less than debt interest rate or negative return) it can really bite you. Therefore, in a good market, debt can be used to increase your returns. In a bad market.. be careful..
I hope I didn’t complicate things… and that it is all clearer than mud.
