A recent posting about debt management piqued quite a bit of curiosity among my readers. The comment responsible was one where I suggested that people put all income against debt and then borrow against the remaining equity to pay for living expenses. While this makes financial sense (and will soon make logical sense to many), it is a rather complicated strategy to implement.
Making Sense Of The Strategy
Unfortunately, I cannot claim any of the glory for this strategy -- it is quite common among high net worth clients. It involves using just one account that is tied into your property. In other words, a mortgage. More specifically, a revolving mortgage where you deposit 100% of all earnings against this mortgage.
Typically, this would be a home equity line a credit facility, or HELOC. Borrowers would then have all of their earnings applied against this HELOC and, when needed, borrow against it for groceries, bill payments (like utilities, etc.) and all other expenses that arise throughout the month.
Financial Benefits
Let's compare a traditional mortgage of $250,000 to a HELOC of the same amount. We will assume the same rate (although the 30-year fixed will be a bit higher). With a mortgage, the monthly payments of $1,454.01 reduce the mortgage to $221,268.88 after five years. That's the easy part.
The HELOC situation is a bit different. Assume that someone who pays $1,454.01 for a mortgage pay other monthly expenses in the amount $1,200. This person (or family) probably earns $36,000 in after-tax income. By putting all $3,000 of after-tax income against the HELOC and borrowing the remaining 1,2000 at the end of the month, the remaining balance at the end of five years is just $182,715.90.
Is It Magic?
No, it's not magic at all. The reason why some HELOC-specific lenders are able to appeal to those who want to repay debt quickly is that most people do not have the discipline to take their extra funds and apply them against their mortgage. Sad, but true.
As well, people who watch their mortgage balance closely have a psychological investment as well. By investing their full bi-weekly payment into a mortgage, people know that taking out that dreaded $1,200 will have a negative impact on their goal. So they more closely monitor their budget.
Can This Work For Me?
That depends on how serious you are about getting out of debt. If you hate debt and want out at all costs, then you can not only make this work, but you can make any debt management system work. Arguably, this strategy makes life a little easier for you.
Talk to your mortgage lender if this strategy is something you would like to explore a little more closely. Run your numbers, make sure it makes sense and that you can remain disciplined. And, I am sure, you quickly see the results of turning your debt into wealth!
