I’m listening to the guys’ interview with Adam Carroll and his Shred method of debt reduction. I’ve seen this before and have always wondered a few things:
At what interest rate level (we are in a rising rate environment) does this HELOC method not work?
What happens if the market crashes and my home loses 10-20% or more of its value?
As I understand, banks can call HELOC loans at nearly any time. So, if the market crashes and my home loses can’t the bank call the HELOC?
Anyone?
I’ve also heard about this in the past and tried running the numbers for my situation in excel but the numbers didn’t make sense to me. For context I was using a 2% mortgage, 1% car loan, CC paid off monthly. It may depend on the situation though.
One thing I couldn’t reconcile in the calculations was that if I just made extra payments to my mortgage using my paycheck (rather than using velocity banking with a 4% HELOC), I would essentially be accomplishing the same thing in the same amount of time without having to pay the “simple interest”. If I remember correctly the total interest I had to pay whether it be amortized or simple came out to be almost the same. Maybe I made a mistake somewhere?
To try to answer your questions:
1)A HELOC is typically variable interest so I think you would probably have to calculate your “break even” interest rate for your situation and monitor the HELOC. I would assume that if your HELOC rate is higher than the average cumulative interest rate of your debt then you might be approaching a break even point.
It’s hard to predict how banks will respond and it will probably vary bank to bank.
2&3) I think in the podcast they addressed this by saying that you should only be utilizing a portion of your HELOC that you’re comfortable with and would be able cover in a worse case senario. ie. only use 5-15k so if loans are called you can cover it. I asked my bank this very question when I opened my HELOC and they said that once I lock in my amount, they would not reduce or call on it even if the market changed, not sure if I would fully trust that though.
The podcast has gotten me a bit interested to run the calculations again just to revisit the results. Maybe I will post them if I get the chance. Looking forward to what others have to say!
@wwong Many thanks for taking the time to reply. I hadn’t listed to the end - had to run - so I didn’t realize some of my questions were addressed. Sorry about that!
Thanks for your input, and it’s interesting to hear your bank’s feedback on not calling the loan. I’d like to believe it, too, but, well, banks…
I am intrigued by this concept, but like infinite banking / bank on yourself, it seems a tad gimmicky, or at least a complex way to solve the problem.
I admit I don’t really get this. I would think a heloc would be a higher interest rate than your mortgage. I can see how taking all the money you keep in your checking and dumping it into your mortgage would reduce interest expense a little but really only be worthwhile for those people who keep a lot of cash in their checking account.
I’d love to see an actual financial analysis in a spreadsheet showing how this works and how much of a difference it makes.
Personally, I make double mortgage payments (escrows included) and I calculated that it has reduced my 30-year mortgage to less than 10.
I heard another podcast interview last year with him and then attended one of the webinars. I dug into the numbers and frankly couldn’t see where it provided any value. I spent a few hours running numbers through spreadsheets and didn’t see an advantage. I don’t agree with paying down my mortgage early, especially with the spread between the mortgage rate and the inflation rate. I’d rather put extra dollars to work in developing additional income streams. In essence, you’re simply using your home equity as a “bank” that you have to refi in order to use again eventually.
I can see the advantage of this method if you have debt other than your home mortgage. For those of us fortunate to not be in that situation, I just don’t see it.
@cshude to your point, it probably depends on the person and if they have any ability or desire to build a business or create additional revenue streams. If they do, then the money is probably better utilized towards those things, because they’ll yield a better return.
However, if a person has no other financial ambition than to pay off their debt, it seems like a much smarter and faster way to knock it out with a simple interest loan product (HELOC) rather than a compound interest loan product (mortgage).
@retipsterseth To add to Seth’s point, the advantage of the Shred Method/velocity banking appears to be the use of average daily rate against compound interest of a loan. Because your HELOC charges you interest based on the average daily rate, you benefit from your paycheck going directly into the HELOC-- it acts as a paydown on the balance even though it may just be there temporarily, as more expenses will add to the balance amount. Essentially the 2-8K most people have sitting in their bank account doesn’t do anything for them–it just loses value from inflation. In this method, your earnings subtract against your HELOC balance, providing a useful (albeit, small) benefit.
Basically you’re leveraging the low interest HELOC to lobotomize your home loan and create a scenario where each monthly payment to that loan–while the same amount out of your pocket–is put to a much higher percentage of the principal. This accelerates the paydown of your mortgage, increasing the equity in your home, while leaving your cashflow situation unaffected.
The other piece of the strategy is using your credit card for most other purchases instead of your bank account, then paying your balance off every month with the HELOC-- this would act as a sort of short-term zero interest loan every month.
I could be missing some pieces of the puzzle, as breaking down complex financial concepts is not my strong suit-- I did a call with the Adam’s sales guy last week, so this is my uneducated interpretation based on one podcast, watching his “Masterclass” video, and one 20 minute phone call.
For land investors, this makes a lot more sense if your HELOC is big enough to use for both land purchases and for velocity banking-- hard to argue that this method would make more financial sense than using the HELOC to purchase vacant parcels for 35% of market value…
The prospect of the HELOC being called due surely exists, though I don’t know what the actual chances would be of that happening on my personal home (I’m sure some property owners from 2007/8 could tell you some horror stories). Personally, seeing the breakdown of where I pay more in interest than principal on my monthly mortgage payment every month (even at a rate of 2.5%) makes me sick, so I may give this a shot. Sounds like Jaren was born-again in the Shred Method, so I’ll be interested to hear his updates, and assuming I move forward with it, I can let ya’ll know how it goes.
@scottholmes yeah, there’s definitely a lot in there. When I spooled up a spreadsheet, I found that simply making extra payments to principal ended up being just about even with the shred method. After considering things for a while (Heard about shred a year+ ago), I think it’s an excellent approach if you have non mortgage debt and feel that you really want to get rid of your mortgage.