At what variable interest rate would you pay off a HELOC?

[Scuba]

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?

 

[FlaGator]

As long as it's deductible, I'd let ride up to 6% or so.

 

[2017ish]

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.

 

[Fedup]

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.

 

[OldShooter]

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'

 

[joylesshusband]

...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.

 

[MichaelB]

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.

 

[OldShooter]

... 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.

 

[ExFlyBoy5]

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.

 

[pb4uski]

+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
1	12,329.09
2	12,329.09
3	12,329.09
4	12,329.09
5	12,329.09
6	12,329.09
7	12,329.09
8	12,329.09
9	12,329.09
10	12,329.09
IRR	4.00%

 

[Blue Collar Guy]

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.

 

[Another Reader]

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.

 

[Texas Proud]

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...

Texas HOA and COA Foreclosures | Nolo.com

 

[Fedup]

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...

Texas HOA and COA Foreclosures | Nolo.com

They do that in California too.

 

[joylesshusband]

+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
1	12,329.09
2	12,329.09
3	12,329.09
4	12,329.09
5	12,329.09
6	12,329.09
7	12,329.09
8	12,329.09
9	12,329.09
10	12,329.09
IRR	4.00%

The benefit from these discussions is the opportunity to consider different perspectives and alternative views, as opposed to seeing everything in black and white. There’s no right and wrong here, I’m just offering my angle.

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

For simplicity, I’m 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 – 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.

 

[Texas Proud]

The benefit from these discussions is the opportunity to consider different perspectives and alternative views, as opposed to seeing everything in black and white. There’s no right and wrong here, I’m just offering my angle.

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

For simplicity, I’m 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 – 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...

 

[pb4uski]

If you can't dazzle them with your brilliance, then baffle them with your ________!

 

[Blue Collar Guy]

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...

Texas HOA and COA Foreclosures | Nolo.com

I should have said the bank never foreclosed. But you get my drift. I sleep better without a payment hanging over my head.

 

[Texas Proud]

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....

 

[Scuba]

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.

 

[Koolau]

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...

Yeah, I had a car dealership try this approach on me. It was like "you take an 8% loan with us instead of paying cash and at the end you're money ahead cause you still have your cash!!" I told him, "yeah, I still have my cash, but I DID have to pay off your loan from SOMETHING, so I'm NOT money ahead. There's that pesky 8% in there that also has to be paid." He tried to argue with me.

I think Scuba can play the game to her advantage and no, I don't know how to figure when to pay off the Heloc. But playing the game sounds like work to me and that's why I retired. I've admitted to leaving money on the table in lots of ways - not the least of which was retiring early. We all have to play it the way we see it. No "right or wrong" just what works for each of us. I'm betting there's a calculator for Scuba's question - but I'm retired.

Oh, and I'd love to see (well, DW would especially like to see) what a $90K (plus) remodel looks like! We've done a kitchen/bath remodel for about $24K and then a second kitchen/bath remodel for about $40K in another place. Both of these were in Hawaii with the "Paradise tax" included. So what do you get for $90K - enquiring minds (nosy folks ) want to know.

 

[pb4uski]

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.

In theory, you would pay it off when the HELOC interest rate exceeds your expected rate of return on the investments. I think I would probably set up an autopay to pay $x per month towards the HELOC until it is paid off... I have a 3.375% 15-year mortgage from a cash out refinance just before I retired and I have the monthly payments on autopay. Since I took out that loan, the earnings rate on my portfolio has far exceeded 3.375%.

 

[Fedup]

I've had auto loan less than 1% and I paid it off. If it's just $90k, why bother. If it's a small amount does it make all that difference?

 

[SpinDr]

From just a personal comfort level I'd pay it off it headed anywhere north of 5%. For the most part, the period I've had HELOCS, it's been better to have the money invested elsewhere versus paying it off quickly. With the markets pretty high it may be a good time to use some of your winnings to pay it off.

 

[OldShooter]

I kind of smile at some of these discussions where a person is planning on future investment returns beating a short-term, fixed, interest rate. I just ran across an amusing quotation:

But in all my experience, I have never been in any accident … of any sort worth speaking about. I have seen but one vessel in distress in all my years at sea. I never saw a wreck and never have been wrecked nor was I ever in any predicament that threatened to end in disaster of any sort. (E. J. Smith, 1907, Captain, RMS Titanic)