TIP 5: Playing With Interest
understanding simple interest and how it works
But Wait One Minute
You may be thinking that we basically traded $5,000 from your mortgage loan balance and placed the debt onto your BLOCso where is the benefit?
You need to understand two important concepts:
- Compound vs. Simple Interest:
your mortgage payment is based on compound interest, which means interest is compounded daily based on a mathematical formula used to calculate the amortization schedule (see Section 1).
Banks will only reduce the mortgage loan balance once per month so any payment that you make to your mortgage will not reduce the balance until the following month meaning that you will pay 1-month interest on the non-adjusted mortgage loan balance.
Home equity line of credit accounts use simple interest. This is where interest is charged on the average daily balance. Every time payments are made to the account, it forces the balance to be adjusted daily.
Since your income goes into the account, the average daily balance remains low. You will pay minimal interest for use of the advanced payment to your mortgage.
Also note that your income deposit becomes your BLOC monthly payment. So you will never make a payment to your BLOC.
- Reducing the Equity Line Balance:
your discretionary income (income that is in excess of monthly living expenses) will be used to pay down your equity line balance.
When that balance has dropped below $500, you will then make another lump-sum payment to reduce your mortgage loan balance:
Starting Credit Line Balance: $60,000
Month BLOC Activity Advances from BLOC Payments to BLOC Balance Owned Sep Beginning Balance $6500 Sep Total Activity $4000 $5000 $5500 Oct Total Activity $4000 $5000 $4500 Nov Total Activity $4000 $5000 $3500 Dec Total Activity $4000 $5000 $2500 Dec Year-End Bonus $2000 $500 Jan Beginning Balance $500 Jan BLOC Pay Down Mortgage $5000 $5500 Jan BLOC Living Expenses $4000 $9,500 Jan Pay Paycheck $5000 $4500 Jan Total BLOC $9000 $5,000 $4500