SLIDE 6: playing with interest
But Wait One Minute!
You may be thinking that we basically traded $10,000 from one debt account to another — so where is the benefit?
You need to understand two things:
First: Compound vs. Simple Interest
Your fixed home improvement loan is based on compound interest, which means interest is compounded daily based on a mathematical formula used to calculate the amortization schedule.
The amortization schedule is used by lenders to calculate how much your monthly payment will need to be in order to reduce the loan to zero after a period of months.
The amortized monthly payment includes a portion for the interest and another portion to reduce the 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 into the account, it forces the balance to be adjusted down - thus charging less interest.
Since your income goes into the account, the average daily balance remains low. You will pay lower interest charges over time than if you were to pay using a straight amortization loan (with interest rates being equal).
Also note that your income deposit becomes your BLOC monthly payment. So you will never make a payment to your BLOC.
Second: Reducing the Equity Line Balance FAST
Your discretionary income (income that is in excess of monthly living expenses) will be used to pay down your equity line balance.
By using your BLOC as your money account, the excess income that you budget through spending will automatically decease your BLOC balance.
Budgeting your discretionary income by $1,000 each month will payoff your home improvement within one year.
Starting Credit Line Balance: $60,000
|Month||BLOC Activity||Advances from BLOC||Payments to BLOC||Balance Owned|
|Sep Beginning Balance||$11,500|
|Jul Beginning Balance||$1500|