How to Hack Your Mortgage Into A High Interest Savings Account

If you happen to follow me on Twitter, you may have noticed I was recently looking into different HELOC options.  The first lesson I learned was to never give a real phone number to LendingTree when attempting to check rates.  Luckily, I thought ahead and used a google voice number instead of my regular cell phone!  Several lenders have been bombarding the number since which would be terrible if they went to the phone I carry around in my pocket most of the day.  While I haven’t actually answered a call (probably why they keep calling…), the voicemails all seem to be based around refinancing instead of the HELOC I was looking for!

While a few people on Twitter seemed to think I was in the market for an actual loan, my true goal was to explore the different ways a HELOC could be used (or not used), how much it costs, and whether or not a financially savvy person could profit off of it in a safe, reliable way.  This article will explore what I learned and if the title didn’t give it away yet, why we plan to start using a HELOC in conjunction with our mortgage to get a much higher return on our emergency fund.

If you happen to have a decent amount of equity in your house, some cash savings, and a bit of financial discipline, you might be able to do the same!

Having Both Debt and Cash is Inefficient

What started me down this path was a small itch that appeared whenever I take a look at the different interest rates in our lives.  We’re currently paying one bank 4% interest on the money we borrowed from them to buy a house (in the form of a mortgage payment).  On the other hand, a different bank is only paying us 1% to borrow money from us (in the form of a high interest savings account)!

That’s a difference of 3% which can add up significantly over time thanks to the power of compounding.

Unfortunately, there’s no simple way to close this gap.  It’s certainly possible to take our cash savings and apply it to the principal (and start gaining 4% on it instead of 1%), but then we can’t access it in an efficient way if we eventually need to use it!  Tying up an emergency fund in home equity is dangerous if you don’t have a way to get it back out quickly.

Once upon a time, mortgage lenders offered a “mortgage savings account” which would have been perfect.  Any money that was currently in the savings account would offset the principal of the mortgage when interest was calculated.  For example, if you owed $100k on your mortgage, but kept $20k in the mortgage savings account, then you would only be paying interest on $80k each month.  This allows you to gain an effective interest rate on your cash savings equal to your mortgage rate, but without losing any of the flexibility of cash.  Money could be withdrawn from the account at any time for any reason, much like a standard savings account.

Of course, most of these mortgage savings accounts were tied to sketchy mortgage lending practices right before the housing crash and completely disappeared in the US not long after.  I’ve heard that they still exist (and are even common) in some other countries, but I haven’t been able to find a US bank that offers them as of writing this post.

For some people, it may be possible to re-create this sort of ideal mortgage based savings account through the use of a HELOC and that’s what we’ll explore below.

How HELOC’s Work

I don’t want to get into all the nitty-gritty details on HELOCs here, so I’ll try to summarize in bullet points and link to a better resource if you’d like more information.

  • HELOC stands for Home Equity Line of Credit and that’s exactly what it is
  • You can think of a HELOC like a credit card, except the line of credit is backed by existing equity in your home
  • A HELOC will typically only be granted up to the 80% of the value of your home (LTV), after taking any existing mortgages into account
  • Cash can be pulled out of the HELOC to do just about anything, it’s cash
  • When a balance exists on the HELOC, you will have to make monthly payments including interest at whatever rate the HELOC is currently at
  • The rates on HELOCs are variable, often based off of the current prime rate
  • Different banks may have various fees and minimum requirements for opening and maintaining a HELOC aside from the interest itself
  • The interest paid towards a HELOC may be tax-deductible much like mortgage interest

More information on HELOCs: Click Here for a Nolo article on HELOC Basics

Are You Eligible for a HELOC?

First, in order to even thing about using the HELOC strategy I describe below, you need to own a home.

Next, you will need some equity built up in that home.  Most lenders will only issue a HELOC up to 80% LTV on your house, which means your outstanding mortgage balance (if any) must be below that.  Ideally, the amount of equity beyond 80% LTV you have should at least be equal to the amount of cash savings you plan to execute this with, ideally more.

Finally, you will need a good credit score and a reasonable debt to income ratio in order to qualify and get a reasonable rate.

Beyond the eligibility requirements a bank will look at above, I would also encourage you to only pursue this if you are financially disciplined, organized, and can handle credit responsibly.

Whether or not it makes sense for you to open a HELOC will depend on the math we’ll explore below.  It appears to work for us, but might not work for everyone.

Why You Might Want A HELOC

Back to the inefficiency we discussed above, it would be ideal if our cash savings could earn at the same rate as our mortgage (4%) instead of 3% lower in our 1% savings account.  Putting our cash savings directly towards the mortgage principal would solve this problem, but creates the new problem of very poor liquidity.  Not being able to access money in an efficient manner would be terrible in a true emergency.

If you have access to a HELOC, it can serve the function of opening up quick access to equity in your home whenever you need it.

In theory this would solve the problem perfectly, but a HELOC doesn’t come without costs.  We’ll first have to run the numbers for a few different scenarios to see if the opportunity cost of keeping our cash savings in a 1% account offsets the potential costs that come with relying on a HELOC to access emergency funds.

The Logistics of Replacing Your Emergency Fund with a HELOC

  1. Open a HELOC, ideally with little to no fees and the lowest rate you can get
    • I’ve found several banks that will open one for $0 in fees and no minimum withdrawal requirement, so it might not cost you a dime to get started.
  2. Take your emergency fund and make an extra principal payment towards your mortgage for the entire amount
    • That money is now effectively earning the interest rate of your mortgage instead of whatever account it was sitting in before.
  3. If you need funds that would normally come from your emergency fund, withdraw them from the HELOC instead
    • Your HELOC may come with checks or a debit card to withdraw, or you can simply make a transfer from it to your regular bank account online.
  4. Use excess cash flow after the emergency to pay the HELOC back down to $0
  5. Rinse and repeat from Step 3 as necessary

Scenario 1: The Ideal Emergency-Free Case

In a perfect world, you’ll never need to access the funds you’ve set aside for an emergency and they will just slowly grow in the background of your life.  While this sounds nice, it’s not particularly practical as many people will probably run into some situation where these funds are required.  Running the numbers for this scenario can be useful though, because it sets a ceiling on what kind of benefit you can gain by using our emergency fund to pay down our mortgage, and then using a HELOC as our new emergency fund.

In order to get the annual benefit, we simply have to subtract your mortgage interest rate from your savings account interest rate, then multiply by the amount of your emergency fund.

As this “ideal” scenario never requires us to actually pull money out of the HELOC, the rate doesn’t even matter.  In fact, it’s entirely possible to open a HELOC and never use it.  Depending on the bank, it might not even cost you any money to just have it available.

For our own example:

  • Mortgage Interest Rate: 4.0%
  • Savings Account Interest Rate: 1.0%
  • Cash Emergency Fund: $18,000

Our Maximum Annual Benefit of Using a HELOC instead of a Savings Account:

  • (4.0% – 1.0%) * $18,000 = $540

An extra $540 per year, which could then be invested to compound over time, is no insignificant sum!

Of course, this is the ideal case with our own personal numbers, so let’s look at some other possibilities.

Scenario 2: The Perpetual Emergency Case

In the opposite of a perfect world, you would always need emergency funding and would never be able to save anything!  If this unfortunate situation starts up right after you decide to move your emergency fund into your mortgage principal, then you will be stuck pulling that money out of the HELOC instead and will be paying the rate of the HELOC instead of just losing out on your 1% savings rate.  The good news is that the money you put towards your mortgage will still keep paying dividends in the meantime.

If the emergency keeps up indefinitely, then you’ll be stuck paying your HELOC’s rate on the entire size of the old emergency fund until the end of time and will never be able to retire.

For this unfortunate (but hopefully very low probability) situation, we can multiply the difference in the rate of the HELOC and the mortgage by the size of your emergency fund to find our worst case scenario.  Of course, HELOC rates are variable, so it is possible for it to get worse as time goes on if you can truly never repay it.

Example:

  • Size of Emergency Fund: $18,000
  • HELOC Interest Rate: 5.0%
  • Mortgage Interest Rate: 4.0%
  • Worst case scenario annual cost: $180 ($18,000 x (5.0% – 4.0%))

That doesn’t seem so bad compared to the $540 in potential profit!  As you’ll see below, this entire life hack depends on your ability to replenish your emergency fund (or pay down the HELOC) quickly, which I think is very possible for most people saving for FI.  It’s people with a high savings rate and a low probability of large emergencies popping up that stand to benefit the most from this strategy.

Scenario 3: A Conservative Case Somewhere In Between

In reality, most people in the pursuit of financial independence have a high savings rate which has a double effect on emergency funds.

First, the chances of needing extra cash in an emergency is diminished because of higher than average monthly cash flow.  Any money that would normally be saved and invested can be redirected towards unexpected expenses as they arise, without ever having to tap into the actual emergency fund.

Second, in the situation where you do need to tap into the emergency fund, it is often possible to replenish the funds quickly by re-directing excess cash flow towards it instead of investments.

Despite these two benefits, let’s calculate a conservatively poor scenario that manages to drain the entire emergency fund yearly, which then takes 5 months to replenish.  This would be equivalent to someone that holds a 5 month emergency fund and has a 50% savings rate.

At a 50% savings rate, you can replenish one month of your emergency fund for every month worked.

This means that half of the year, the HELOC is carrying a balance while the other half of the year it sits unused.  The first month the HELOC carries the full balance, then it decreases over the next 5 months until it’s entirely paid back down to $0 at the end of the 6th month.  The average balance of the HELOC over these 6 months is exactly half of the total emergency fund.  The average balance across the entire year would then be half of that, or a quarter of the emergency fund, as the HELOC sits unused at a $0 balance the other half of the year.

We can then use this number (25% of the emergency fund total) to calculate whether or not we are still seeing a benefit from using the HELOC instead of a savings account by subtracting it from the ideal number we calculated above.

Example Numbers:

  • Mortgage Interest Rate: 4.0%
  • Savings Account Rate: 1.0%
  • HELOC Rate: 5.0%
  • Size of Emergency Fund: $18,000

Conservative Annual Benefit Estimate of Using a HELOC instead of a Savings Account:

  • Average HELOC Balance: $4,500 (25% of $18,000)
  • Interest Paid on HELOC: $225 (5.0% x $4,500)
  • Interest Not Paid on Mortgage because that’s where our $18k in cash is: $720 (4.0% x $18,000)
  • Average Balance that would have been in our old Savings Account E-fund: $13,500 ($18,000 – $4,500)
  • Interest Not Gained because we no longer use a Savings Account: $135 (1.0% x $13,500)
  • Total Annual Profit of HELOC Strategy for this Scenario: $360 ($720 – $225 – $135)

As you can see, even in what I would consider an unfortunate annual use of an emergency fund, the HELOC strategy described above still comes out ahead of just keeping your emergency fund in a savings account!

Here’s the same example in excel form that includes the real cash flow numbers I was looking at when considering this strategy for ourselves.  I focused on the total interest that we would be paying and gaining both with the HELOC strategy and without.  I subtract any interest that would be paid on the mortgage balance (at 4%) and HELOC (at 5%) each month, but then add back in interest that would be gained from having cash in a savings account (at 1%).  I ran the numbers over 2 years which means there was 2 instances of the “emergency fund drain” described in this scenario.  We can then compare the total interest paid in each example to see which one came out ahead and by how much:

The numbers in yellow at the very bottom of each picture account for the total interest paid in each plan.  By subtracting the two values from each other, we find that the HELOC strategy ended with us paying $774.21 less in interest over the two years.  That number is a little higher than our calculation of $720 above ($360 x 2 years) because the 4% saved on the mortgage balance essentially compounds over time to create even more savings.  And that’s with having to fully drain our emergency fund twice and make interest payments towards the HELOC!

Why This HELOC Strategy Works for Us

Each of the scenarios above uses a close approximation of our own numbers to calculate the potential savings and costs in different possible scenarios.  The HELOC strategy works so well for us because of the reason I listed above, we are saving a high percentage of our income each month.  This excess cash flow allows us to use our emergency fund less and replenish it quickly in the event we ever do need to use it.

One way to look at it is this:  For every month the HELOC sits at a $0 balance (no emergencies), we are profiting $45 by having our cash savings in our mortgage principal instead of a savings account.  Over time, we should have many more months without an emergency than months with one.

Even when we do have an emergency and need to drain the account, there is hardly any cost to do so!  The only cost will be on the difference between our mortgage rate and the HELOC rate (1% in our example numbers above) multiplied by the average balance of the HELOC.  This is because even though you are paying the HELOC rate on the balance, you are still profiting your mortgage rate each and every month because you made that extra principal payment at the beginning!

Another way to look at it is the break-even point.  What is the average utilization of the emergency fund in which both strategies are equivalent?  The approximate answer is simply the ratio of your mortgage rate to the HELOC rate!  I say approximate because the compounding of the mortgage and the interest on the savings account balance both offset it slightly.

For the numbers we were using above, this would be 80% (4.0% / 5.0%) or an approximate average HELOC balance of $14,400 (80% of $18,000).

A little trial and error with the excel sheet I was using revealed that the real average HELOC balance that will create the break-even point is $14,238.75 for the example numbers we’ve been using throughout this page.

That means if we expect our average monthly use of your emergency fund to remain under 80%, then we will profit by using a HELOC and sending our cash emergency fund to pay down our mortgage principal.  As we haven’t even had to touch our emergency fund since we set it up years ago (knock on wood!), the average use over time shouldn’t even be close to 80%.  If we would have started this strategy 3 years ago, it would take a crazy emergency that would drain our entire fund for 12 years just to bring us back to even!

Every year we don’t start doing this we’re leaving hundreds of dollars on the table for taking on a very low amount of risk (more than 4 out of every 5 years being a catastrophic emergency kind of risk).  I can’t believe I didn’t run the numbers on this sooner, but at least we’ve discovered it now!

Why This HELOC Strategy Might Not Work For You

A lot of the math above has been based on our own personal numbers and I will be the first to acknowledge that this strategy isn’t a good idea for most.

  1. It requires financial discipline to not spend money out of the HELOC unnecessarily.
  2. It requires a level of comfort with having little to no cash buffer sitting around in your accounts.
  3. It requires approximate estimation of your worst-case scenario emergency fund usage over time.
  4. It requires slightly higher cash-flow during a worst-case scenario because of the minimum payments on the HELOC.  This is because your mortgage payment remains constant despite the extra payment we made early on.
  5. It benefits greatly from a high savings rate that has the ability to replenish emergency funds quickly.

Fortunately, I think the financial independence community is the perfect candidate for meeting and exceeding the requirements above!  Of course not everyone in the FI community will be comfortable bringing their cash emergency fund down to $0, but even just reducing your emergency fund and moving the rest into your mortgage principal could allow you to profit from this strategy.

In addition to the above requirements, I recommend calculating your own potential profit and downside.

How To Get Started Yourself

If the above strategy and potential profits from it caught your attention and you meet the requirements above, then the first step is to shop around for a HELOC with a good rate.  I used 5% in my example, but this is actually on the high end of different rates that I was able to find at the time of writing.  I kept it anyway to show that the HELOC doesn’t necessarily have to be equal or cheaper than your current mortgage rate (but of course that would help!).

In fact, the best rate I found advertised online was from Third Federal Savings and Loan which is currently at prime minus 0.51% or 3.49% for HELOCs over $50,000.  That’s even cheaper than our mortgage rate!  But don’t forget HELOC rates are variable, so this will potentially go up over time.  Third Federal even advertises a “lowest rate guarantee” that will pay out $1,000 if you can find someone with a lower HELOC rate!

If you’re able to find a HELOC with little or no fees that has a lower rate than your mortgage, you can effectively play interest arbitrage by pulling money out of the HELOC and putting it towards the mortgage.  This increases your cash flow requirement each month as you’ll have the additional HELOC payment, but you will accelerate your mortgage to some degree.  This of course comes with it’s own bag of risks that are beyond the scope of this article.  In general, I would advise against it!

Also, I don’t have any relation with Third Federal, they just happen to be the lowest rate I found searching around online.  One downside to their offering is a $65 annual fee after the first year. This may make a higher rate with a different bank a better deal over time.  Of course, this will depend on how much you actually end up using the HELOC.

I’d recommend asking any banks you currently have an account open with, the big banks seem to have higher rates in general, but offer different “rate discounts” depending on how much money you hold with them.  Next, local credit unions may be your best bet, Danny Salgado on Twitter mentioned a prime minus 0.25% rate in Vancouver Washington in response to my HELOC tweet:

After you find a HELOC that might work for you, run the same calculations I ran above with your own numbers.  Maybe you’re getting higher than 1% on your cash savings right now.  Maybe you have a different interest rate on your mortgage.  In most cases, I expect you will still be able to profit each year, but you’ll have to decide for yourself if it’s worth the effort.  Don’t forget to subtract out any fees you are paying to open or maintain the HELOC year over year (it’s possible this is $0).

Suggested Calculations:

  • Best Case Scenario Annual Profit: (Mortgage Rate – Savings Rate) * Size of Emergency Fund
  • Worst Case Scenario Annual Loss: (HELOC Rate – Mortgage Rate) * Size of Emergency Fund
  • Average Case Scenario Annual Profit/Loss: (Mortgage Rate * Size of Emergency Fund) – (HELOC Rate * Average HELOC Balance) – (Savings Rate * Average Savings Balance)

Not sure how to figure these numbers out?  Let me know in the comments and I’ll do my best to help you out!

Overall, I’m super excited to try out this strategy myself and start profiting hundreds of dollars per year!  What about you?  Does this seem like a sound financial optimization or am I missing something that makes it way too risky for your liking?  Let me know in the comments below and I’d love to talk about it.

Cheers!


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50 thoughts on “How to Hack Your Mortgage Into A High Interest Savings Account

  1. Is your ability to draw for the HELOC typically open indefinitely without reevaluation of credit? For example, someone needing to use emergency funds might also have a dip in their credit or income. Are you guaranteed to be able to draw from the HELOC once it is issued?

    1. Out of the different banks I talked to, most offered HELOCs that were set up with a 10 year draw down period followed by a 20 year repayment period. During the first 10 years, I think the required payment was interest only while the last 20 years were amortized like a mortgage to have consistent payments each month and eventually pay it off at the end.

      Towards the end of ~10 years, it should be possible to close the existing HELOC and open another one to reset the draw-down period if your goal is to continue following the strategy above.

      While the HELOC should be “guaranteed” so long as the equity in your house is still there, I’ve read that several people had their HELOCs closed or frozen during the last housing crash. This was partially because housing prices dropped significantly at the time, so equity to loan against disappeared, but also because some banks were giving HELOCs up to 120% LTV! I’ve never heard of one being frozen/cancelled due to a drop in income/credit, but that doesn’t mean it couldn’t happen.

  2. You could accomplish this similarly, albeit for shorter terms, through balance transfer checks. By virtue of having access to six figures in unsecured credit thanks to past App O Ramas I get BT checks basically every other week. Normally those adware shredded but I could see myself using the checks if needed, for a 1%-3% APR loan. Then if the emergency persists I would draw down from I Bonds or do a HELOC then. I do think it is prudent to have a HELOC on the property after I pay down the mortgage, if only to provide some asset protection and not be an easy target for having a free and clear home.

    1. When you take a cash advance using balance transfer checks, you often have to pay a full 1-3% fee up front just to pull the money out. Even though a HELOC will have a higher interest rate than that, it’s spread over an entire year which means you should only end up paying a fraction of it, often much less than 3% on the amount taken out.

      Unless you’re getting different kinds of balance transfer checks than I am, this could work as a more expensive version of the same thing. The risk is much higher if you aren’t able to pay it off though because the interest rate will jump up into the 20’s at the end of the 0% APR grace period. Or you’ll be stuck paying another ~3% to transfer to another card if your credit is still in good shape at that point.

      I’m not sure what you mean by a HELOC protecting your home as an asset. Wouldn’t your risk of being sued and losing your house be the same whether or not you have a HELOC?

      1. The HELOC acts as a lien and helps strip away some of the assets. It might deter some creditors. Obviously adequate protections in insurance, fully funding retirement accounts, etc is paramount (and I do that) but this is a backstop. http://m.assetprotectionattorneys.com/Domestic_Asset_Protection/Equity_Stripping/How_to_Discourage_Lawsuits.aspx

        I am paying down my mortgage though primarily because it’s the highest interest rate loan I have (2.79% through Third Federal). I have a margin account with IB that has a rate of 2.41% and I am regularly buying ETFs as I normally would on margin. This is portfolio margin so I have the ability to have substantial leverage, although I am currently only at a 2:1 ratio.

        1. Thanks for the link and info, sounds like something worth thinking about.

          Buying stocks on margin sounds risky, but I’m sure you’re being compensated in much higher returns because of it. Have you looked at what kind of impact a market crash would have as you’re leveraged up on margin? The concern I’ve always heard is that if the market goes down significantly, your margin will be called and it will become impossible to ride out the downturn until it eventually bounces back because you were forced to sell.

          1. With portfolio margin on diversified ETFs you could go up to 6:1 margin (15% equity) and not have any issues. I agree I am taking risk but I have cheaper margin rates than a mortgage rate. As far as Third Federal and appraisals, which was mentioned by another poster, their appraisal requires an interior visit, at least for my reappraisal.

  3. Great post Noah. Do you know if your line of credit updates if your LTV situation changes? Or does increasing the line require a new appraisal?

    1. I don’t know for sure, but I don’t think the HELOC line is typically adjusted as time goes on.

      Now, it should be possible to close down an existing HELOC at the same time as opening up another one to take advantage of additional equity in your home. Just watch out for any early closure fees or similar.

      Most of the banks I talked to myself didn’t even require an in person appraisal, they would use some kind of electronic assessment and then you could request a more formal appraisal if you aren’t happy with the result.

      1. The HELOC amount is not adjusted. As you pay down your mortgage and have a higher equity, you can ask the bank for an increase.

  4. I specialize in doing this with KeyBank. All of the info here is great.
    Our heloc allows you to lock the rate up to 3 different times.
    We also go to 85- 90% ltv which is unheard of, allowing some to get the product that may not have a chance otherwise.

    Feel free to reach out

  5. I’ve done this for awhile. We have a HELOC through the same bank I have checking. My HELOC is $0 right now, but I use it as a backstop for any credit card payments that I wasn’t quite tracking (due to all the credit card signups, not REAL spend). It just automatically pulls from the HELOC if I’m overdrawn, no fees, no fuss (happens couple times a year). It really gives me peace of mind to not have to track the timing on all those credit card payments, except what I’m actually spending. And I can keep my checking balance relatively low. I don’t have an emergency fund, and actually never have. It’s always worked out (I know that’s a no-no, but it’s just how I am; I put it in retirement).

    1. Having a HELOC act as an overdraft feature sounds great! It seems like you could effectively keep your checking account at $0 by moving all excess cash into investments or towards the mortgage principal, have payments come out of the HELOC, then pay the HELOC off when new cash comes around.

      I’m starting to lean towards you on not having an emergency fund at all. Cash is a large drag on gains over the long run and a combination of our high savings rate, access to a lot of cheap credit, and taxable investments we could liquidate in a crazy situation, there just doesn’t seem to be a benefit of having a pile of cash sitting around.

      Thanks for the info!

  6. Somewhat off topic, but this whole premise is based on your Savings interest rate (1%) being lower than your Mortgage interest rate (4%). As I’m sure you’re aware, there are much higher Savings interest rates. Insight for one. Each person is allowed two cards, so you and your SO could have 20k saved there (higher than the 18k in this post) and be making 5% interest. Why not just do that? Then you can use the interest gained to pay down your mortgage if you wanted.

    1. Not off topic at all, and you nailed the reason this is profitable. It’s totally dependent on the spread between savings and the mortgage interest.

      I’m definitely aware of the different high interest savings accounts that exist out there, but haven’t found one compelling enough to make the extra effort of using it worth-while. So long as we have the mortgage open at 4%, we can leverage a HELOC to get that 4% return on a much larger amount of money than most of these accounts offer. I’m betting on this being more sustainable (and simpler) over time than juggling cash between multiple accounts with different monthly hoops to jump through, plus these accounts seem to come and go which requires work every time the terms change.

      Doctor of Credit has a great resource for anyone who is interested in these high interest accounts:
      http://www.doctorofcredit.com/high-interest-savings-to-get/

      Definitely a good option if you don’t mind the complexity and can’t leverage something like a mortgage.

      Personally, I’m not in any rush to pay off our mortgage and any extra cash goes into investments instead. I’m betting on the long term return of the market to beat 5% by a good margin, so even these high interest accounts should cause portfolio drag over time.

  7. Great article!

    Just to make sure I don’t misunderstand. Is the below summary accurate?

    – the ‘profit’ you mentioned here is not ‘profit’ in a traditional sense, but rather, refers to the savings gained by making extra payments towards principal balance each month, and therefore resulting in less mortgage accruing over time, correct?

    – and these extra payments would come from the emergency funds you have had with you all this while. But you want HELOC as a security or insurance tool in case you need to pull out money from the house to address unexpected happenings or real life situations , if it unfortunately happens

    – your goal is always to keep HELOC balance at $0 so that you don’t accrue interest and can maximize the ‘profit’ mentioned in first bullet point

    Thanks in advance for your patience – I m not a finance person but trying to learn by reading ever since I owned a home

    1. Thanks MG!

      You’re correct in that the profit in my examples results from less interest paid towards the mortgage. With the long term goal of growing wealth (increasing net worth), $540 towards mortgage principal is just as good as $540 in your pocket unless you’re strapped for cash.

      Correct, I used the example of making a one time extra payment towards your mortgage of the entire cash emergency fund balance, but it would work with smaller amounts as well (for smaller benefit). Yes the HELOC is now your emergency plan.

      Correct, keeping the HELOC at 0% is optimal, but as I showed, even being forced to pull money out of it on occasion and pay it back over time will still end up better than if it was sitting in cash the whole time.

  8. There’s a serious flaw in your terminology, and the whole idea is misleading. In Scenario 1 you said: “An extra $540 per year, which could then be invested to compound over time, is no insignificant sum!” This $540 is not “profit” and does not translate to immediate “savings”. Paying down the principal does not change the minimum monthly mortgage payment — you’ll pay those $514 towards the mortgage, but it’ll apply to the principal instead of interest. That money does not stay in your wallet and cannot be invested into anything else. It effectively accelerates the mortgage payoff.

    If you were able to refinance the mortgage to reduce the monthly payments after paying down the principal balance, then your analysis would be valid. Unfortunately, refinancing frequently may not be possible or practical.

    1. You’re correct! That line is little misleading, but I think it gets the point accross. I wanted to mention that the $540 does act as an investment in that you continue to get 4% return on the new savings each future year (aka compounding). The $540 is still profit as it increases your net worth and I would count that as savings.

      While you can’t easily take the $540 out and invest it in something else, it does automatically get “invested” in the mortgage principal to continue growing at the mortgage rate each year.

      Refinancing is definitely a way to pull that money out if you really need the cash or want to lower your monthly payment, but I agree that should be the exception rather than the plan.

  9. I concur with what Not Quite said above. Additionally, if instead of keeping your emergency fund in a savings account that accrues little interest (or even +1% in a high interest account), you kept the emergency fund in a relatively conservative investment account (e.g., Betterment) with an ETF-only investment strategy, you’d stand to gain far more than your suggested strategy.

    1. First, I want to clarify that ETF can mean just about anything. It could be an index, a group of stocks, real estate, bonds, gold, and much more. Simply having an “ETF-only” investment strategy is the same as just having an investment strategy, it’s what ETFs you choose that make the difference.

      As you mentioned conservative, I assume it would be a high % of bonds, but even that isn’t protected from market crashes. The main reason to avoid putting your emergency fund in something volatile is that you may actually lose money when you need to access it. In fact, bonds are projected to return less than 4% in the near-term, so that would most likely lose out to the mortgage strategy even if you didn’t have to sell at a loss. You’re adding additional risk for no gain.

      Now investing in a stock market index ETF like VTI should have a higher return than your mortgage, but once again it’s subject to volatility. In fact, several reasons you might need an emergency fund are tied to the market itself which increases your chances of this strategy back-firing and causing you to lose money when you need to access the funds. That’s not to say it can’t work, if you never need to access the funds you should come out way ahead, but I don’t think it’s worth the risk. The HELOC strategy above allows you to have additional gains with a very small amount of risk.

      More info about mortgage vs. bonds from ERN:
      https://earlyretirementnow.com/2016/11/02/why-would-anyone-have-a-mortgage-and-a-bond-portfolio/

  10. This is terrible advice for anybody who was remotely awake during the 2007-2008 financial collapse. Don’t think you bank can’t take your HELOC line away from you. Working in the industry, we closed people’s HELOCs at record numbers. That means these people were not able to count on them any longer in the case of emergencies or other plans when the RE markets start to sour. The takeaway should be that you should keep your emergency funds liquid(as you state) and not tied to any underlying asset as collateral that is subject to market or interest rate risks. That means stocks, bonds, and especially real estate. I personally do 3-mo emergency salary in the 1% savings and another 3-mo savings in investments such as vanguard index ETFs. Returns average 3-4% in this market and the potential downfall wouldn’t be too bad on a market free-fall as I am able to exit at any time.

    1. Based on what I’ve read, a lot of HELOC’s were frozen or closed out because the equity that was backing them disappeared in the housing collapse. One of the biggest problems was that a lot of banks were issuing HELOCs up to 120% LTV and using severly inflated home prices to do so which was extremely risky.

      You do bring up a good point that real estate value isn’t a guarantee, but I highly doubt we’ll see a crazy drop like we did in 07-08 anytime soon. This will of course vary by location and type of property (vacation rentals are probably much more susceptible to an unexpected drop), so one should factor that risk in to their overall strategy.

      Your 3-month liquid plan seems fine and I’m sure is in balance with your risk tolerance. Expecting to be able to pull out the other 3-months ahead of a market free-fall is just market timing, so I think it would make sense to just consider that as part of your investments rather than an emergency fund. It’s ok to use your taxable investments as a back-up to your liquid e-fund.

  11. Zach, the problem with having your emergency fund in an ETF is volatility. You are likely to desperately need that emergency fund when the economy tanks, the stock market crashes and you lose your job at Lehman Brothers all in the same month. Your emergency funds might be halved in days just when you need it. If you had the cash, treasuries, CD’s or the HELOC you would still have the full amount. Safety is the primary consideration for emergency funds.

    In some instances the ETF strategy could be advantageous. Say you need an emergency fund of $20k. If you put $50k into an ETF then most likely you will still have $20K even if the stock market crashes and meanwhile you earn superior returns on the money.

    1. I agree in general, but I’m not sold on the last part of $50k in ETFs acting as a $20k emergency fund.

      In that case, you’ve just decided to use your taxable investment account as your emergency fund which comes with the volatility risks mentioned above. This strategy will be highly dependant on the person, their risk tolerance, and their approximate chances of needing an emergency fund (and when). Bad timing could wipe out all of the superior returns you earned on the money previously.

      If you never need to tap the emergency funds, then optimizing return is ideal, but most people like to knock out some of the downside risk in the event they do need to tap into them. As always, it comes back to personal risk tolerance.

  12. You guys are such optimists. This idea only works if you don’t have a Black Swan event, like losing a lawsuit, getting really sick, or not being able to work for an extended period of time.

    Paying interest on a years worth of living expenses without an income would really suck. I guess if you got yourself employed again, you could refi and pay off the mortgage. If, if, if.

    Financial planning should cover the worst eventualities, don’t you think?

    1. In the black swan events you’ve mentioned, a standard size emergency fund of 3-6 months isn’t going to help much either, even if it is liquid in a savings account.

      As I calculated above, the only risk you are taking is between the mortgage rate and HELOC rate (should be <2% in the current market). In my examples, we're trading 3% upside against 1% downside in the worst case emegency that drains the emergency fund balance.

      I'd argue that in this black swan event you describe, having a HELOC open will be extremely beneficial if you do end up having to access more funds than you originally set aside in the emergency fund. In that event, you will be able to borrow money at a very low interest rate against your home equity instead of attempting to get a personal loan with no job or running up a balance on credit cards at 20%+ APR to pay for life.

      As the price to get a HELOC is so low (potentially $0), having the largest line open you can would be extremely beneficial in a black swan event.

      If your entire financial plan is based around worst-case scenarios then your overall plan will suffer and you'll end up working much longer than is necessary in most cases (if you're ever able to retire at all). Being too conservative will end with you being worse off in most long term situations, it's all about finding the right balance of risk and having contingency plans for unlikely events.

  13. Noah, I did say that the most important consideration of an emergency fund is security. However, my point is if you don’t want perfect safety in cash, CD’s or treasuries that must mean you have a high risk tolerance so a high balance ETF would be an option. I don’t think being in a taxable investment is significant because if you have to pay tax on sale that means you have gains and you have not lost on the investment. If there is a market downturn and the $50K has dropped to $40 or even $25K then you would have no gains to tax and might even be able to carry losses forward for a tax benefit later. However given past market history you are much more likely to have a gain than a loss.

    El Ingeniero, no amount of financial planning can cover all the worst eventualities. It can only help cushion against the more likely, short term scenarios such as a medical expense or short to medium length unemployment. Really if you become a depressed alcoholic compulsive gambler you are toast no matter how much an emergency fund one has or if you gets sudden rapidly degenerative Alzheimer’s you better hope you have a good partner that can earn money.

    1. I only mentioned taxable for the accessability compared to retirement accounts like a 401k, didn’t mean to bring up any of the tax implications, but you covered them well.

      My only hesitation would be situations where you need an emergency fund overlapping with situations that the market has dropped. I agree the returns should be higher in most cases, but the cost of that is additional risk.

      This post’s intention was to lay out a better alternative than keeping your money in cash that didn’t have the additional market conditions risk. Using ETFs instead is a whole different discussion.

      1. Noah, I agree. My main point was that if someone did want to use an ETF as an emergency fund then they should put at least twice as much as they think they needed in to account for market volatility. As my example, if you need a $20K emergency fund and wanted to keep it in an ETF then you should put in $50K.

  14. That’s a cute idea that looks good until a recession hits and the bank closes your HELOC. HELOCs aren’t guaranteed.

    1. HELOCs aren’t guaranteed, but neither are a lot of other investment strategies in life.

      Many HELOCs were closed in the last recession because they exceeded 80% LTV and were built on way overpriced property. Recessions in general are not always based around housing as the catalyst, and I imagine in most of them HELOCs are quite safe.

      In a recession, a bank is also looking to make money, so it’s in their best interest to maintain the HELOC and allow you to draw it down assuming there is still home equity to back it up. The reason they can offer low interest rates is because the HELOC is backed by an asset (the house), so even if you default the bank will likely come out ahead.

  15. noah. nice blog. i dont really comment here but you do some good shit.

    anyway, after doc linked to this post and reading the comments, i wanted to say a few quick words because it should be clear to you that this HELOC strategy is terrible IMHO, but thats just me. youre a smart guy so please get more input and revisit the strategy and make sure your 100% solid on this. doesnt sound like this is an emotional decision for you and heavy logic and math was used, but using HELOC as ur eFund is a terrible idea.

    i really dont understand why youre so focused on a HELOC. ur pro at using CC now so you should understand that a HELOC is a big fat huge credit card. HELOC is revolving debt and it will show up that way on your credit report as a credit card. NOT a mortgage. you already know different lenders use all kinds of FICO scores and it will calculate ur HELOC totally differently. maybe as mortgage. maybe as CC. ur score may take a huge hit depending on the baskin robins FICO flavor being used.

    its also seems like ur risk adverse which is great but its hypocritical talking about market crashes but then using ur house as a credit card. haha. cmon bro!

    my last point is cash is KING. cashflow is KING. u cant beat 12 months of money sitting in your 1% that can be used anytime anywhere worldwide FDIC secured with no market fluctuations. put that crap in schwab sitting there collecting dust. i say schwab so you can get cash around the world bro. any money over 12 mo pay down ur house. simple.

    take care man!

    1. Ninjax, you say Cash is King and Cashflow is King however the two don’t always go together. Cash at 1% generates negligible cashflow. Cash at 1% is guaranteed but it is also guaranteed to lose since inflation is higher than that. Also I think that a HELOC with a zero balance would have small but minimal impact on your credit score. The HELOC idea is not for everyone but it is not a terrible idea.

    2. Thanks Ninjax.

      I still think this strategy is optimal for our situation. I can’t imagine what your response would have been to the post I had planned before this where we were just going to get rid of our cash emergency fund without even having a HELOC.

      I agree a HELOC is basically a credit card, but it’s one with a huge limit and a very low APR. The FICO consideration is one that I’ve thought about, but based on what I’ve read it should impact our score the same as a new credit card would, especially if the balance is $0.

      Not sure I understand the hypocritical part, the HELOC is a way to access funds without having to sell in the event of a market crash. I’d say this strategy wouldn’t fall under the “risk-adverse” category as there is a bit of risk in a worst-case scenario.

      Totally agree that cash is king and we have high cashflow on a monthly basis because of our savings rate, plus we could manage just fine on either of our two incomes in the event of a job loss. There’s no way I’m going to keep ~$50k in a 1% account, that would be a good definition of high risk adversity in my book.

      Having that money in cash is a risk by itself because of inflation and a few other factors, over the long run that cash value will depreciate while investments will appreciate. That’s a big difference that could result in backing up our retirement and success rate significantly.

      I’m not saying there is no value in holding cash, but the bigger that pool gets the slower your wealth grows over the long term.

  16. I love these kinds of creative money management ideas. I have a post where I discuss how to use a VA Mortgage (0% down and low interest rate + No PMI) to purchase rental property and this is another great post about being creative to get better returns. I have one more thing to add to your list of requirements for using this HELOC/Savings strategy: you have to own your home! Aka, renters need not apply!

    1. Thanks for the comment, I did include owning a home as the first requirement though:
      “First, in order to even thing about using the HELOC strategy I describe below, you need to own a home.”

      Cheers!

  17. You’re overpaying if your first mortgage is at 4%. Instead of these HELOC shenanigans, why not simply refinance into a lower rate mortgage. PenFed 5/5 is currently going for 3%.

    Our first mortgage is 2.75%, so any HELOC borrowing will be at a higher rate.

    1. Refinancing to a variable rate ARM mortgage has it’s own set of risks to consider, and we don’t plan to pay our mortgage off early so 30-year fixed seemed like our best option. Especially in what I would view as an environment where interest rates will grow going forward (this is speculation of course).

      As I looked at with the examples above, even a HELOC with a higher interest rate than your mortgage could come out ahead. Your potential gain/loss in the different scenarios will shift, but you have to run your own numbers to see if it might be beneficial.

      1. Yes, but if you look at a 10 year time horizon you enjoy the lower rate the first 5 years, and even if the adjustment in the second five years is the full two points, you come out even with a fixed rate.

        There is some risk of the rate rising, but with a fixed rate, I’m already paying a higher rate in the early years.

        Penfed also has a 15/15 – still cheaper than a 30 year fixed that gives same benefits. Most won’t be in the same property for 15 years.

        1. The 15/15 from PenFed can jump up 6% after the first 15 years and the initial rate isn’t much lower than 30-year fixed right now, there is certainly no guarantee that will come out ahead of locking in a 30-year fixed now. If some other type of loan was strictly better than fixed, then why would fixed even exist? Any variable rate mortgage is going to have an element of risk built in which may or may not end up with you profiting from it.

          For our own situation, even if we don’t plan to be in the house in 15 years, it’s more likely that we’ll rent it out than sell in order to buy our next place. I still think locking in a 30-year fixed at 4% was our best option. That doesn’t mean a different option might not work better for others.

  18. I skimmed the article which presents an interesting idea, but in the ideal situation, your cash reserve = your HELOC credit line (thus effectively earning the “4%” and not paying any of the HELOC interest) , in that case, would the key reason for me to not 1) simply pay up the house 2) invest in something with >4% return be that necessity of keeping that emergency fund and liquidity?

    Thanks

    1. Great question! My goal with this article was to show a low-risk way to get a higher return on someone’s cash emergency fund.

      Having said that, your suggestion of opening a HELOC to use as the emergency fund and investing the cash emergency find instead of paying down the mortgage is certainly an option. At that point, you no longer get the guaranteed 4% return, but instead get the return of whatever you choose to invest it in. Most investments have some volatility while paying down the mortgage will not, but over the long run it should be possible to come out ahead. That means your best case returns will go up, but your worst case returns end up much lower in the event you need to draw funds from the HELOC on a regular basis and your investments perform poorly.

      It ends up being the same math as paying off a mortgage versus investing. The math says investing is better over the long-haul, but many people choose to do the opposite, mostly because of their own personal risk-tolerance.

  19. You assume rates will stay this low for a fee more years. If rates go up your help will jump too and you could end up with a much higher rate in case you need it.

    1. I never made that assumption and I specifically ran the examples above with a higher than average HELOC rate in the current market. Even if rates go up, there is a good chance you will still come out ahead with the above strategy.

      Having said that, it’s important to re-evaluate your options on a regular basis. There is almost never a one-size-fits-all solution in finance, especially over many years and even decades. If HELOC rates go up, then you should absolutely consider switching back to a cash emergency fund when the risk/reward profile no longer fits your own preference. The beauty of the above strategy is that it’s almost completely reversible if you change your mind in the future.

  20. When people move to another state, do they often buy a new house before selling the old one? If yes, then I think it’s better to have high cash reserves than high equity in the old house because the latter is not a liquid asset. I’m not sure whether the old house equity will be considered at all when qualifying for the new mortgage.

    1. Hey Nik, I’m not sure what most people do, but this strategy shouldn’t prevent you from buying/selling in either order.

      Even if you wanted to buy a new house before selling, it would be possible to take a large amount of cash out of your existing equity via the HELOC before getting a mortgage lined up for the second place. Assuming your HELOC rate is relatively close to the mortgage rate, you’d still probably come out ahead versus having kept cash the entire time.

      I think the most important factors when qualifying for a mortgage are size of down payment and debt to income ratio. Assuming your income(s) can cover both mortgages at the same time and you have enough of a down payment, I don’t see why I bank wouldn’t lend to you in general. Of course, there are other factors aside from these, but they seem to carry the most weight when getting approved.

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