When I was discussing Mortgage interest, I received a few emails asking to to spell out a bit more clearly how regular mortgages calculate interest vs how home equity lines of credit (HELOCs) calculate. Fair enough.
One disclaimer; before you act on my explanation here, confirm with your bank that your mortgage is as I describe. I share here my understanding and experience, but it’s certainly possible that your bank follows different rules.
A standard fixed mortgage with a due date of the first of each month will often have a grace period allowing payments up to the 10th or even the 15th of the month with no late fee and no extra interest accrued to the account. On a monthly payment of $1200, this extra 15 days float is worth about $36 assuming a 6% mortgage. You see, it’s money available 15 days per month or half the time, so half of $72 is $36. Not a huge sum, but if your bank has a grace period this generous, you can save a bit by taking advantage. Just as the bank may have a grace period, they will not offer you any savings by paying a week, two weeks, or even a full month early unless you specifically note the extra funds are to go to principal. In that case the next regular payment is still due on the upcoming first of the month.
A HELOC, on the other hand, charges interest to your account based on average daily balance. I know of no bank that will lend you money from the 1st to the 29th but if your balance is $0 on the 30th will charge you no interest. That suggestion is absurd, and repeated by people who are either very confused, or those trying to perpetuate a lie. Just because someone in the mortgage business believes he “borrowed the bank’s money interest free” doesn’t make it so. In fact, it undermines his credibility as well as the agent who uses such nonsense as “proof” and a testimonial. To be clear, whatever the rate is on your HELOC is multiplied by your balance at each day’s end and accumulated over the course of the month. If you borrow money on the 1st and pay it in full on the 3rd, that’s 2 days interest. If you run a small balance, this may just amount to pennies, but you are still being charged this interest each day.
MMA agents will confuse you with this even more easily than they confused this mortgage broker. They will suggest that there’s some magic to the the way HELOCs calculate interest vs how the standard mortgage calculates. There may very well be a few dollars savings to be captured, but that’s nothing compared to the $1000 you are prompted to pay each month from your own money. Don’t be confused into believing the software creates this savings. In fact, when you ask an agent to run an analysis using as little discretionary income as possible, you’ll find they offer you numbers that easily show the lack of value of this software. I’ll discuss their analysis further in a couple weeks.