How to Turn Your House into a Bank
How to Turn Your House into a Bank … AKA The HELOC Snowball™
There is a lot of debate as to whether or not you should pay off your house. I think that we should be asking a different question. How best can you utilize the equity in your house?
There are some significant hurdles to overcome when thinking about potentially paying down the mortgage on your primary residence.
If I pay down my mortgage, my payments remain the same, so have I really accomplished much?
If I commit a decent amount of money to paying down my mortgage and then need it back later … that's a problem. I would have to refinance my mortgage to get that money back out, and the refi isn’t free and can be time consuming.
I can put my money in an investment whose returns are higher than my mortgage interest rate, so shouldn’t I do that instead of paying down the lower rate mortgage?
These are the questions that I struggled with anytime this topic came up. I wanted to make the best use of my money, but I also hated the thought of having a mortgage payment for the rest of my life. I also hated the thought of having equity sitting trapped in my house. I kept coming back to this knowing that there had to be some kind of hack here.
That’s when I stumbled onto two key tools:
The HELOC (Home Equity Line of Credit)
Recasting your mortgage
It was through utilizing these two tools that I have turned my house into my own personal bank.
First let’s cover the HELOC
It is exactly what it sounds like. It is a line of credit that you can use for pretty much anything you like. You can typically find a bank that will allow you to create a HELOC for up to 80-90% of the value of your house based on a recent appraisal. For example, if you have a house worth $400k and you owe $250k on your mortgage, you have $150k of equity in your house. Say a bank will give you a HELOC up to 80%. 80% of $400k is $320k. So, this bank would give you a line of credit for $120k (the difference between the max they will allow ($320k) and what you still owe on your mortgage ($200k)). We will come back to how to utilize this in a minute.
Now let’s cover the recast
After paying a large lump sum toward your mortgage (thereby reducing the amount of principal you owe) you can then recast your mortgage, which takes the new amount of principal owed and re-amortizes it over the remaining years on your mortgage. This will reduce your monthly payment, thereby increasing your monthly cash flow. If you pay a lump sum toward your mortgage and do not recast it, your monthly payments will typically remain the same and you will just end up paying your mortgage off sooner. There is absolutely nothing with this option, but ‘sooner’ may be paying it off in 15 years instead of 25. That’s a long time to wait for that lump sum payment to impact your cash flow. Recasting your mortgage typically costs a few hundred dollars … significantly less than a refi.
Let’s look at some recast numbers
A $250,000 30-year mortgage at 3% has a principal and interest payment of $1,054/mo. If you pay it down with a lump sum payment of $50,000 and then recast it, your payment would be $843/mo.
Each of these are pretty cool tools in their own right, but putting them together is like a home equity, mortgage paydown, cash flow increasing superpower! They combine together to form what I like to call The HELOC Snowball™ … and yes, this feels trademark worthy 😊. I have dreams that this becomes the next ‘BRRRR’ or ‘House Hack.’ It’s kind of like Dave Ramsey’s debt snowball … but different. And rest assured, Dave does not support the HELOC Snowball™ (because Dave doesn’t support any kind of debt). We can get into Dave’s thoughts on debt another time, but I believe that these tools are too powerful to ignore.
The HELOC Snowball™ is best explained by example.
Let’s stick with the numbers we used earlier and say that our buddy Steve owns a house worth $400k and still owes $250k on his mortgage. We know from the previous example that he can get a $120k HELOC. But Steve just got a bonus at work of $50k and he wants to put it all toward his mortgage. So, Steve pays his mortgage down by the $50k, which means that he now owes $200k. Steve can now get a HELOC for $170k. He can also recast his mortgage and re-amortize the $200k over the remaining term on his mortgage and significantly reduce his monthly mortgage payment.
Now let’s say that Steve utilizes the HELOC to invest in deals that generate a return decently above the interest rate on his HELOC. This is generating Steve increased cash flow on top of his already increased cash flow from recasting his mortgage. Let’s also say that Steve is throwing every extra penny he has at paying off the HELOC that he just drew on for his investment. He’s taking the returns from his investment, all of this increased cash flow, and any other additional funds and paying that HELOC down. Every time he pays his HELOC down his cash flow goes up even further. The snowball is starting to grow.
Once Steve gets his HELOC completely paid off, he decides to do it again. Steve finds another great investment and starts this process over again … but this time Steve has 2 deals (his first deal is still paying him along with his new investment) helping pay his HELOC down along with all of the increased cash flow and any other additional funds he can come up with. With 2 deals working to pay that HELOC down it gets paid off even faster. The snowball is starting to get pretty big!
Steve continues this process until he has a handful of deals all paying down his HELOC after every new investment. Then, his first investment (let’s say Steve had invested in a small apartment complex as a limited partner) sells for a great profit and Steve gets a check for $50k. Steve takes that $50k, pays his mortgage down even further, recasts his mortgage again, and now has an additional $50k added to his HELOC for future investments.
Steve continues this process until his mortgage is completely paid off and he has a HELOC for the full $320k. Steve still has all of his existing deals generating cash flow for him and a HELOC ready to go for the next great investment that comes along. Steve has now turned his house into his own personal bank.
A few additional things to think about when considering going down this path …
You may want to consider converting your entire current mortgage over to a HELOC
What I mean by this, is that your bank may allow you to take your entire current mortgage balance and convert it to a HELOC with that amount drawn. There are a few advantages to this. Most HELOCs allow you to pay interest only, and the interest is only on the amount you have drawn. This means that at any point you can choose to pay interest only if you find yourself in an unanticipated financial bind and need more cash flow.
On the flip side, many people find it addicting paying down their HELOC because it increases their cash flow every time they do it (as opposed to a conventional mortgage where your payment stays the same unless you recast it).
There is also no significant risk of paying too much toward your HELOC and needing it later because you can just pull that money back out at any time. You can pay $5,000 toward it on Monday and then pull $2,000 back out on Tuesday. This allows you to be very aggressive with your paydown. Some people have been known to send their entire paycheck to their HELOC and then pay their bills/expenses out of the HELOC. This is known as Velocity Banking. This strategy minimizes the amount of interest paid on your HELOC since you are keeping its balance as low as possible.
I love to utilize the HELOC Snowball for syndicated (passive) deals
I find this to be a cool mindset shift. I think of the syndicated deal as a rent house and I’m the tenant. And I am the greatest tenant that I could ever have! The distributions from the syndicated deal are my job, but even if I lose my ‘job’ (the distributions are less than expected), I have plenty of additional income to cover the rent (the interest payment). I also never throw parties or break the toilet!
Random note that is loosely related … if you have rental houses with equity in them that you could refi and pull out, pull that money out and use it to pay down your primary residence.
It is always better to have equity in your primary residence than in a rent house. It is easier to access, and it creates more security. By more security, I mean that if your financial world gets turned upside down, would you rather have a bank foreclose on your primary residence or your rental property?
Cash flow is king
Forget everything you know about what a mortgage is and what banks expect. Would you prefer to pay a fixed principal and interest payment that never changes, or would you prefer to have the ability to choose to pay as much or as little as you like toward principal? Option 2 certainly takes more discipline as it inherently has more freedom. And option 1 is always there. But if you truly want control of your finances, option 2 is available. Most people just don’t realize that it’s an option.
Next, think of your mortgage from a cash flow standpoint and compare it to an investment. It is common to hear that if your mortgage interest is lower than what you can get by investing your money, you should never pay off your mortgage. If you subscribe to this way of thinking, then you would always have a mortgage payment. Even after taking the full term (typically 15 - 30 years) to pay your mortgage off ... with this way of thinking, it would only make sense to take out another mortgage on you home and start over. If you would never pay it off … you would never pay it off. So it makes sense to assume that you would have this P&I payment for the rest of your life. This means that you cannot equally compare your mortgage’s interest rate to a higher investment return.
Let’s think in increments of $100,000.
A $100,000 30-year mortgage at 3% has a principle and interest payment of $422/mo.
You would have to get an annual return of 5.1% on $100,000 invested to generate $422/mo.
Investing $100,000 in an investment that provides an 8% annual return generates $667/month.
So, the comparison should not be between 3% and 8%. It should be between 5.1% and 8%. Yes … 8% is still more, however, we have to account for risk. Paying down a 3% mortgage is equivalent to getting a risk free 5.1% return. Everyone has their own threshold for risk, and mine is pretty high. But even with my high tolerance for risk – due to all of the other advantages and freedom that the HELOC Snowball provides … I choose paying it down and creating the snowball.
While we’re at it, let’s look at a few things to consider when shopping for the best HELOC in town.
All HELOCs are not created equal. Find the best HELOC deal. Call a dozen or more banks. Look for a long term (at least 10 years … and I’ve seen 25) before in converts to P&I (you can always just refinance your HELOC at the end of the term), low int rate (it will be variable), highest % of home value (look for at least 80%, but you may be able to find 90%), how long your appraisal is good for (look for 3 years) and a first year introductory rate.
Ask your bank if they will just convert your remaining mortgage balance to a HELOC. If they won’t, then pay down as much as you possibly can and recast your remaining mortgage. Remember, you can pull this money right back out once you establish your HELOC. This maximizes how much of your cash you can put to work for you. You can also feel more comfortable with a smaller cash emergency fund/reserves if you have access to your home equity at any time.
There are more tools than most of us realize that are available to us to win the money game. Look at it as a game … a game you can win. Don’t be afraid of having too much control. If your goal is financial freedom, trust Jocko Willink … discipline equals freedom. Take control, come up with a strategy, and be disciplined. These things aren’t as complicated as they seem.