Properly Using A Home Equity Line Of Credit
Can Save You Thousands Of Dollars! 

Many people already have a HELOC (Home Equity Line Of Credit), but don't realize what a powerful tool it can be.  They simply use it to borrow against their home whenever they run short on cash.  That however, is not the best way to use it.  It's much more powerful to use it as an Interest Savings (or Interest Offset) Account.

An Interest Offset Account can be called many different things, but what it means is you are taking any available cash that is earning a low interest rate ( checking, savings etc. ) and using it to offset a higher interest loan.  In this case, we are taking money and using it to offset part of our mortgage principal balance.   This causes your mortgage balance to be lower and saves you a considerable amount of interest over time. 

How Much Can You Save?   Here is a quick example:  If you had a $150,000 mortgage at 6% interest and earned $5000 per month, you can save $24,730 over the life of your mortgage by using your HELOC in this way.  

In this case, you would set up a HELOC ( Home Equity Line Of Credit ) that was at least $10,000.   Then you would write a check ( or do an online transfer ) out of the HELOC to your mortgage company for $5000.   This will reduce your mortgage balance by $5000, so you will be paying interest on $145,000 instead of $150,000.   Now, when you get paid you will want to deposit your paycheck into your HELOC so you "offset" the $5000 that you transferred from your mortgage.  By doing this, you have effectively eliminated $5000 of debt that you have to pay interest on.

When you pay your bills, simply write a check out of your HELOC instead of using your old checking account.

What is a HELOC and why is it different from a Home Equity Loan?

A HELOC is a Home Equity Line Of Credit.  In most cases it is a second mortgage, however their are some 1st position HELOC products from CMG and Macquarie.  For our purposes, we will be using a standard second position HELOC which is available from most banks.  A line of credit is not the same as a loan, it is simply available credit that can be used when necessary.  There is no fixed principal payment, but interest is paid monthly.  Since a HELOC is a line of credit, it's interest rate is not fixed.  Most have variable rates that are tied to the Prime Rate or Libor Index, so they tend to be follow the Fed Funds rate which is set by the Federal Reserve.  In times of economic weakness ( now for example), rates can go extremely low and when the economy gets strong the rates tend to rise.  Since we are using this account as an Interest Offset account, the interest rate is not much of a factor.

As you can see, interest rates are usually quite a bit lower for HELOC's than for Home Equity Loans.  

Additionally, the larger your HELOC credit line is the lower your interest rate will be.  It is just as expensive for a bank to set up a $10k HELOC as it is a $50k one, so the rates tend to be better on the larger ones.  As I said however, since our primary use of this account will be to "offset" interest costs, the rate doesn't really matter.

To set up your HELOC account, I recommend doing online research prior to visiting with your local bank.  Then you can see if your current bank can match the offers you found online.  Let them know you need a HELOC that allows you to write checks, use Bill Pay and has a debit card attached.   The goal is to have all the same functionality as with your regular checking account.

Fees, Discounts and Penalties:

In most cases you are not required to make any initial draw on the credit line, however if you don't use it within 6 months some banks will close down the credit line.  Interest rates are usually slightly above prime rate for a small HELOC, the example below is for a $30,000 line of credit.  You can see that State Bank and Gate City offer Prime ( P) + 0% with no interest rate floor, no yearly fee and a minimum line of $5-6k.  Chase offers Prime - .25% on larger HELOCs and no setup fee.  Each offer is slightly different so be sure to get the full details before making a decision.

The functionality of the account is more important than the interest rates, because we will not be carrying a large balance on the HELOC only enough to offset your monthly deposits ( paychecks etc. ).

The main attributes you want with your Home Equity Line Of Credit to have are:

Easy To Transfer Money
Unlimited Free Check Writing
Debit Card
No Required Draw
Minimal or No Closing Costs

Make sure you review "Getting A HELOC" for the features you want before talking with your banker.