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At what variable interest rate would you pay off a HELOC?
Old 06-15-2017, 06:12 AM   #1
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At what variable interest rate would you pay off a HELOC?

DH & I took out a HELOC a couple of years before we RE'd to finance a major home remodel. We have the cash to pay it off fully, but have left a balance of around $90K on it so that we could keep our cash invested in the market. So far this has been a really good decision.

With the latest rate hike, our HELOC rate will be at 3.99%. Still earning more on our portfolio, but as rates go up I want to set a "threshold" since paying off this HELOC has a guaranteed rate of return. I realize many on this forum don't believe in debt at all, but this HELOC is a VERY small percentage of our assets. Also we are still in a fairly high tax bracket for 2017 so the tax benefit is nice.

For those of you not averse to "smart" debt, how high would the rate have to go before you'd pay it off?
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Old 06-15-2017, 06:23 AM   #2
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As long as it's deductible, I'd let ride up to 6% or so.
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Old 06-15-2017, 07:16 AM   #3
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I don't know that I'd look at it in isolation. Taking FlaGator's example of 6%, sure that'd be awful high in today's markets. But, in 1986, a 6% rate would have been so attractive that people would be lining up for the free money.

The key would be how the rate compares to the earnings on whatever investments you would sell or forego to pay the HELOC off.
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Old 06-15-2017, 08:05 AM   #4
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I paid mine off but I did use some HELOC in 2013 and invested in the stock market. That year the stock market did very well. I think the ratio has to be 30% return vs 3% HELOC rate, but I won't play with smaller ratio. The higher the interest the lower probably the stock market will do well. Just keep that in mind. Since you wrote this is a small amount of your portfolio, why bother.
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Old 06-15-2017, 09:46 AM   #5
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If you look around one afternoon and see that your equities have taken a 20% hit, this idea of borrowing short and (effectively) lending long might not seem so attractive. Just sayin'
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Old 06-15-2017, 12:16 PM   #6
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Originally Posted by Scuba View Post
...paying off this HELOC has a guaranteed rate of return.
It does not.
It's a loan, not an investment, hence it has no "rate of return" whatsoever.
Trying to apply investment-suited terms to liabilities does not make any sense, and is in fact detrimental to one's thinking, as it results in a fallacy illustrated in the next paragraph.

The loan (mortgage) interest fallacy:
A current rate of 3.99% does not mean that you have to pay back 3.99% of the outstanding principal. If you keep on paying off the loan per the original schedule, the total of your interest expense would be slightly above the 1/2 mark of the 3.99% due to the shrinking outstanding principal. Call it 2.1% for simplicity and you won't be far off the actual total.

This simple fact is consistently overlooked by posters in financial online discussions although said posters think themselves astute. For instance, in all threads discussing the "should I pay off my mortgage" theme going some 8-9 years back here on e-r.org, the inmates treated the mortgage apr as if it was a "return rate" instead of seeing it for what it is - a simple interest rate over a diminishing principal....
I find this hilarious although it's quite embarrassing!

My take on your situation is to keep servicing the loan up until its rate exceeds 7.5% (close to 4% actual) as even your most conservative investments would return at least 4% in the long run.
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Old 06-15-2017, 12:42 PM   #7
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If I have two options to apply cash, one is a financial investment, the other is paying down debt, I would consider the elimination of future interest payments as "guaranteed return" comparible to investment returns, which are never guaranteed. It's neither hilarious nor embarrassing, just my view.
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Old 06-15-2017, 12:52 PM   #8
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Originally Posted by joylesshusband View Post
... A current rate of 3.99% does not mean that you have to pay back 3.99% of the outstanding principal. If you keep on paying off the loan per the original schedule, the total of your interest expense would be slightly above the 1/2 mark of the 3.99% due to the shrinking outstanding principal. Call it 2.1% for simplicity and you won't be far off the actual total. ...
This makes no sense to me. If the interest rate on the unpaid balance is 3.99% then that is the interest rate. Period.

If you want to look at the total dollars paid in interest over the term of a loan, it is fairly accurate to approximate the amount you'll pay interest on as half the original principal balance. But for a ten year loan, that approximation will be ten times the interest percentage times half the principal balance. So for a $100K loan @3.99% that is approximately $20K. ($21,437.14 according to one internet mortgage calculator). As a percentage, 20% of the original principal amount.

But so what? You're still paying 3.99% on the unpaid balance and that is the number to use when making decisions. The term of the loan and the payment amount are irrelevant.
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Old 06-15-2017, 01:00 PM   #9
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Originally Posted by MichaelB View Post
If I have two options to apply cash, one is a financial investment, the other is paying down debt, I would consider the elimination of future interest payments as "guaranteed return" comparible to investment returns, which are never guaranteed. It's neither hilarious nor embarrassing, just my view.
I would agree with Michael's sentiment. We have an open HELOC, but currently has a 0 balance. I debated using it as "capital" to drop into the market, but then realized that could be a terrible idea. I am of the mindset that I want very little liability (debt) as possible (meaning ZERO with few exceptions). Having a mortgage free home was one of the motivating factors for me being fully FIRE'd and I would like to keep it that way. Nonetheless, the HELOC is a good tool to have funds readily available in a pinch, so that is the utility I get out of it.

As to the OP, if I had a balance on it, I think I would look to pay it off when it got to about 4.5%. Granted, that's a arbitrary number, but just my preference. Also, the mortgage deduction is a fallacy in a lot of cases...as a matter of fact, because my taxable income is relatively low, I would have to have a very LARGE mortgage to get a deduction that is bigger than our standard deduction.
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Old 06-15-2017, 04:04 PM   #10
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+1 The avoidance of a cash outflow is as good as a cash inflow.... simple economics that may people fail to understand.

Let's say that someone has an obligation to pay $12,329.09 a year for the next 10 years (the loan payments on $100,000 principal balance at 4% interest for 10 years).

All of a sudden, $100,000 falls from the sky. The recipient decides to pay off the loan. They pay out $100,000 today and avoid having to pay $12,329.09 for each of the next 10 years. The IRR of the cash flows is 4%.... so by paying $100,000 today they effectively earn 4% by avoiding having to make the payments.

0-100,000.00
112,329.09
212,329.09
312,329.09
412,329.09
512,329.09
612,329.09
712,329.09
812,329.09
912,329.09
1012,329.09
  
IRR4.00%
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Old 06-15-2017, 04:19 PM   #11
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I got one when i bought this place to pay for the extras. I think it was around the 3.25 % range. I paid it off as fast as i could, no one ever foreclosed on a paid off house. I sleep better at night knowing if everything goes sour, the market, my pension, i drop dead, the bride lives in a free and clear house. I was already FIRE'D when i took out the HELOC , building a bigger legacy or maximizing my nest egg is second to peace of mind.
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Old 06-15-2017, 06:24 PM   #12
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I'm paying the variable portion of my Wells Fargo HELOC off, as the rate rises with the prime rate. The fixed rate portion expires in a year and a half, so that's next.
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Old 06-15-2017, 08:59 PM   #13
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I got one when i bought this place to pay for the extras. I think it was around the 3.25 % range. I paid it off as fast as i could, no one ever foreclosed on a paid off house. I sleep better at night knowing if everything goes sour, the market, my pension, i drop dead, the bride lives in a free and clear house. I was already FIRE'D when i took out the HELOC , building a bigger legacy or maximizing my nest egg is second to peace of mind.

Not quite true everywhere.... down here if you do not pay your neighborhood association dues they can foreclose.... I do think there is an exemption for seniors.... but did not see it here... maybe that is for taxes...

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Old 06-15-2017, 09:05 PM   #14
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Not quite true everywhere.... down here if you do not pay your neighborhood association dues they can foreclose.... I do think there is an exemption for seniors.... but did not see it here... maybe that is for taxes...

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They do that in California too.
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Old 06-16-2017, 08:27 AM   #15
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Originally Posted by pb4uski View Post
+1 The avoidance of a cash outflow is as good as a cash inflow.... simple economics that may people fail to understand.

Let's say that someone has an obligation to pay $12,329.09 a year for the next 10 years (the loan payments on $100,000 principal balance at 4% interest for 10 years).

All of a sudden, $100,000 falls from the sky. The recipient decides to pay off the loan. They pay out $100,000 today and avoid having to pay $12,329.09 for each of the next 10 years. The IRR of the cash flows is 4%.... so by paying $100,000 today they effectively earn 4% by avoiding having to make the payments.

0-100,000.00
112,329.09
212,329.09
312,329.09
412,329.09
512,329.09
612,329.09
712,329.09
812,329.09
912,329.09
1012,329.09
  
IRR4.00%
The benefit from these discussions is the opportunity to consider different perspectives and alternative views, as opposed to seeing everything in black and white. Thereís no right and wrong here, Iím just offering my angle.

In your example, you conveniently ignored the opportunities after the loan's term is over.

For simplicity, Iím ignoring COL/inflation below.

$100k falls off the sky in your lap. Instead of using it to pay off your loan outright, you invest it. A most conservative allocation generates real 4% each year during the life of your loan (10 years) amounting to $40k if you consume it Ė or $48k if you reinvest it.
Then it continues to generate averaged 4% return during the rest of your life, say another 20 years, amounting to another $80k (assuming consumption) or $224k (assuming reinvesting).
So, you began with the $100k, it provided you with a total of $120k income (consumption) and you still have the 100k principal - or it grew to $324 k if gains were reinvested.
Of course, you have meanwhile spent 10 years * $12,3k = $123k to dispose of the loan, $23k of which were interest paid. You end up with plenty of net gain in either of the consumption case or the reinvestment case. You took measured risks (the ones you are already fully accustomed to, as an investor and as a debtor).

In the scenario where you used the money to pay off the loan, you gave up the opportunity the $100k afforded you, however your saved yourself $23k of interest. You eliminated the (barely) existing risk of defaulting on the loan, took no new risks, and reaped no rewards.
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Old 06-16-2017, 10:39 AM   #16
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The benefit from these discussions is the opportunity to consider different perspectives and alternative views, as opposed to seeing everything in black and white. Thereís no right and wrong here, Iím just offering my angle.

In your example, you conveniently ignored the opportunities after the loan's term is over.

For simplicity, Iím ignoring COL/inflation below.

$100k falls off the sky in your lap. Instead of using it to pay off your loan outright, you invest it. A most conservative allocation generates real 4% each year during the life of your loan (10 years) amounting to $40k if you consume it Ė or $48k if you reinvest it.
Then it continues to generate averaged 4% return during the rest of your life, say another 20 years, amounting to another $80k (assuming consumption) or $224k (assuming reinvesting).
So, you began with the $100k, it provided you with a total of $120k income (consumption) and you still have the 100k principal - or it grew to $324 k if gains were reinvested.
Of course, you have meanwhile spent 10 years * $12,3k = $123k to dispose of the loan, $23k of which were interest paid. You end up with plenty of net gain in either of the consumption case or the reinvestment case. You took measured risks (the ones you are already fully accustomed to, as an investor and as a debtor).

In the scenario where you used the money to pay off the loan, you gave up the opportunity the $100k afforded you, however your saved yourself $23k of interest. You eliminated the (barely) existing risk of defaulting on the loan, took no new risks, and reaped no rewards.

You do realize that the example given can be extended to infinity and still come out to 4% return

And even in your example, the loan has to be paid off after 10 years by some means.... so you calculations do not take that into account...
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Old 06-16-2017, 02:20 PM   #17
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Old 06-16-2017, 02:50 PM   #18
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Not quite true everywhere.... down here if you do not pay your neighborhood association dues they can foreclose.... I do think there is an exemption for seniors.... but did not see it here... maybe that is for taxes...

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I should have said the bank never foreclosed. But you get my drift. I sleep better without a payment hanging over my head.
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Old 06-16-2017, 03:19 PM   #19
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I should have said the bank never foreclosed. But you get my drift. I sleep better without a payment hanging over my head.

Oh yea... I knew what your were talking about..... but I do not know if they can foreclose where you are if you do not pay HOA dues... just wanted that thrown in the mix...


I am surprised that people here let it get to that point... I read about our neighborhood hiring a lawyer to foreclose on two houses that have not paid in 3+ years so I know it is happening even in a good neighborhood....
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Old 06-17-2017, 05:24 AM   #20
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I'm not concerned about debt hanging over my head when I can easily pay it off anytime. I'm interested in others' thoughts about how high rates need to go before they would take cash out of the market to eliminate debt. Thanks for your perspectives on this.
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