We’re continuing our Q&A series this week and today I handle these two questions:
- 00:01 Melissa heard about an idea of using a HELOC to pay off your primary mortgage as a method of paying off the loan faster and saving interest costs. This was referenced in the book “Master Your Debt” and the website TruthInEquity.com.
- 38:13 Robert asks about the safety of the deferred comp plan that he and his wife participate in at her Fortune 500 Public Utitlity company.
Enjoy the show!
Joshua
I found the second part interesting, as I also have one of these. Ours is invested in a 60/40 type stock/bond portfolio of mutual funds. It wasn’t clear what the questioner’s was invested in, but that is definitely a risk factor, as anyone who got stuck in the Enron ESOP knows. Much better if its in diversified investments than all tied up in the company.
The biggest benefit, however, is not having to pay taxes on the money at the questioner’s marginal tax rates, which sound like they are in the higher range. With proper planning a company can help its employees shield $100K or more of income in tax deferred accounts if you include an employer funded SIP (401k), a voluntary portion of that and one of these non-qualified plans.
The questioner should also investigate what happens when his wife leaves employment. If it is set up favorably, she may be able to get a payout and roll it over her interest directly into a self-directed 401(k). This minimizes the risk to only the time she remains employed there. But if she is not able to do that, that would be a strike against the plan. Still, I have to believe/guess that the tax benefits outweigh most of the risks here.
Interesting discussion on the HELOC question. The upside I would see that you sort of skipped over was that you would have the benefit of the cash that would normally sit in your checking account earmarked for paying monthly bills reducing your loan balance until it goes out to pay credit card, light bill, etc. This would have the effect of reducing your average loan balance for the period and thus your interest expense.
That said, I don’t see the interest savings being substantial enough to justify paying a huge fee to set the system up, especially since as you note you get a similar effect by just throwing all your excess to the loan balance on a traditional mortgage. It does make me interested enough to research a little and see if there is a way to set this up for minimal cost.
I didn’t mean to skip over it, but I think it’s massively overblown in impact. I can’t recreate their exact chart, but when I simply add the extra monthly payments to a traditional amortization schedule, I get almost exactly the same time frame.
I think they’re marketing the “average daily balance” benefit, but in reality it can’t save more than perhaps a month of payments, if that.
I’m open to being proved wrong by the proponents of the system, but I want to see the numbers proving an equal comparison only of lower average daily balance, not mixing up interest rates, extra payments, and average daily balance.
Let me know what you find if you figure out a way to set it up yourself cheaply.
I appreciate how you pointed out the “picture painting” the HELOC people used to try to make their system sound like a great thing. I think you could probably make a whole show out of reading sales copy and pointing out the red flags.
My kids are still young, but I have already decided that listening to a few hundred hours of Clark Howard will be a requirement to graduate from our homeschool. I want them to learn how to avoid being scammed. I think I may end up adding episodes of your show to the personal finance class.
I’m actually thinking about starting a regular book review show in which I’ll do exactly that: point out all the great stuff and then point out all the nonsense. Might be a YouTube project for me.
The piece is great, thanks for some logical input. The title … sorry to be a pill but I think you mean “Safe”, not “Save.”
I’d agree that this book, and perhaps the whole concept of mortgage acceleration, has a ridiculous amount of unnecessary rah-rah and detail – some misleading and some just unnecessary – that makes me suspicious. The basic concept just isn’t that complicated.
The problem I personally have with the concept is this: While on one hand this concept could make it easy to apply all your extra income to your mortgage and give you a slight leg up by temporarily applying your whole salary to the principal, it simplifies your investment / debt / finance process by putting all your money / debt in one big pile, and it keeps you “safe” if you lose your job, it has great potential for abuse. It makes living within one’s means irrelevant. It means it’s easily possible five years later to wind up with exactly the same principal you started with.
I just came across your podcast and after listening to your comments regarding mortgage acceleration, I wanted to add my 2¢ to the discussion. I am somewhat of an expert in the so-called Australian mortgage acceleration system, so I listened to your analysis with interest.
First, most of the people selling this financial system don’t understand it themselves, and so their advice to prospective users/clients is flawed. For one thing, a user should NEVER replace their first mortgage with a HELOC. It’s just wrong, and extremely dangerous.
Second, it’s not necessary to use a HELOC, as other short-term loan products are available to consumers (for example, an overdraft line of credit on the homeowner’s regular checking account. Credit unions are good sources as well.
BTW, another way of understanding this system is that it uses a short term loan to replace a small portion of a long term loan.
You are correct in your observation that most of the interest reduction of this system comes not from parking income against the line of credit, but from additional payments toward principal. However, people don’t realize the detrimental effect of interest on their long-term finances (retirement savings). A $300,000 mortgage isn’t a $300,000 debt, it’s a $600,000 debt. Homeowners don’t look at it in this manner. That $300,000 of mortgage interest is not trivial. Impressive, life-changing interest reduction of this system (my system, not the others) is the inclusion of the accelerator in an overall financial planning system.
My website, MortgageMagicSystem.com, is actually a retirement planning system. It utilizes mortgage acceleration within a comprehensive financial plan that helps homeowners reduce interest costs from all sources, such as credit cards. Each user customizes it for their particular circumstances and it provides them a fairly simple financial planning tool with predictable results. It includes charts and monthly feedback to stay focused and on track month to month.
I’ve also written a book “The Retirement Conspiracy” that is on Amazon.
The Mortgage Magic System costs $475, which I believe is very reasonable.
I realize I’m late to the discussion…
I think you all are missing one of the key points. This system works well if you have an emergency savings. Instead of having that money sitting in the bank getting 0.1% interest you can use it to offset the mortgage interest. Assuming you have equity in your house you set up the HELOC so you can get to the money in an emergency. Otherwise you shouldn’t touch it.
If you have 3 to 6 months of money saved for emergencies then you will see significant interest savings and shortening your loan duration. For me, I have split my emergency fund into two parts. 1/2 that is liquid as long as the banks are solvent and 1/2 that is liquid as long as I have a HELOC. That means I have reduced my mortgage by 10% (I can get to the money in my HELOC so it’s fluid like syrup) and still have 10% liquid (like water) earning 0.1%.
Why don’t I reduce my mortgage by the other 10%? There is risk in the system. The part that gets dangerous is that your emergency funds are in your house and you can only get to them via your HELOC. If the housing market crashes again and the banks start closing down distributions on your HELOC again you would be stuck because the money you have for emergencies is tied up in the house.
Of course this system does not fix stupid. So if you can’t live on a budget or within your means, then the system isn’t for you and you should stay far from it.
Where are we going in 2016 and beyond is the question…