When you’re trying to pay off your mortgage fast, it all comes down to interest. Interest is the amount of money you owe over and above the principal of a loan, paid on a regular schedule at a specific rate based on how much money you borrowed. In traditional mortgages, interest is calculated monthly and is based on an amortization schedule. Your payment stays the same each month, while the amount of money going toward interest and the amount going toward the principal shifts over time. The interest you owe shrinks as the amount being applied to the principal increases. Most homeowners find it difficult to pay down an amortized loan quickly unless they can make large payments to the principal balance. But HELOC interest calculation is different.
How Does HELOC Interest Calculation Differ?
A home equity line of credit (HELOC) is a simple interest loan. And the benefits of using a HELOC are rooted in the way interest is calculated. Simple interest means interest is calculated every day. In addition, it’s based on the remaining amount of money you owe – not the starting amount of the loan. Understanding this distinction is critical because reducing your principal means quickly reducing the amount of interest you’ll pay in total.
Here’s an example of how to put a HELOC interest rate to work for you using a simple interest calculation. Then, we’ll show an amortized interest calculation and see how they compare.
Let’s start with a 5% rate. Interest for each day is .05 divided by 365. (.05 / 365 = .00136). Multiple this number by the month’s average daily balance. If the balance is $200,000:
- Daily interest accrued is $27.40
- During a 30-day month, interest is $821.92
- During a 31-day month, interest is $849.32
For a typical mortgage with the same rate (5%), the rate is divided by 12 (.05/12 = .00417). That number is multiplied by the previous month’s ending principal balance. If that balance is also $200,000:
- Interest payment is $833.33, no matter how many days are in the month
The difference in these two calculations matter if you’re attempting to pay down your mortgage faster than the typical 30-year schedule. As your balance goes down, so does the amount of interest you owe, leaving more of your income each month to once again be applied to your principal balance. In short, a HELOC lets you use your full income every month to pay down your debt – all while giving you the complete financial access you need to feel secure. For more real-world examples and a deeper dive into how you can use a HELOC to change your financial future, download the free ebook Take Control of Your Equity.