How can I pay off my home mortgage faster? This is a hugely popular topic and typically the answer is to pay down extra principal each month. In recent years, there has been another concept being pushed which is the P.I.L.L method, Principal Isolation Leverage Liquidity. Does this method really work? Let’s dive into it!
There are numerous YouTube videos that talk about the P.I.L.L method. Usually showing someone at a whiteboard scratching out numbers and hand drawn graphs. It’s pretty easy to gloss over the actual numbers this way, trying to sell a theory or concept. I decided to pull out my trusty friend Excel and get to the bottom of it.
The P.I.L.L Method Overview
The general idea behind the P.I.L.L Method is to take out a loan that operates on simple interest like a Home Equity Line of Credit (HELOC) or use a credit card. This money is then used to pay down the mortgage principal in a significant lump sum payment. The end result? You pay less mortgage interest each month, so more money from your payment goes towards paying down additional principal.
Now you have two loans, the mortgage and the HELOC or credit card debt. The next step is to pay down the credit you used to get the funds for the large mortgage pre-payment. When it is paid off, you do the same thing again. Rinse and repeat until you pay off your entire mortgage.
This doesn’t really sound like a great idea on the surface. Take out higher interest debt to pay down lower interest debt. The next step is the purported magic sauce to make this work. The HELOC or credit cards work off simple interest that is based on the average monthly balance. Let’s take the HELOC for example. It is a revolving line of credit that means that you can pay down and take back out of it as much as you want, as long as you stay under the credit limit.
If you take out a HELOC for $25,0000 which you use to pay down your mortgage, the principal balance will go down by $25,000. That means you will be saving the mortgage interest every month on that $25,000 that was paid off. The next step is to take all of your income and pay down the HELOC, which reduces the balance on that loan as much as possible. You then pay each of your bills at the last possible moment from the HELOC. The goal is to spend as many days each month with the HELOC balance as low as possible, to minimize the amount of interest you pay on it.
This is essentially a form of financial arbitrage, where you are trying to maximize interest savings by playing a shell game with your debt.
Does it work? Let’s find out!
Financial Scenario Overview
Let’s setup the scenario then play this out and see how the P.I.L.L method stacks up.
You bought a $250,000 home with 20% down at 4.5% on a 30-year fixed rate mortgage. The monthly mortgage payment is $1013.37 on the $200,000 loan. The goal is to pay off the mortgage in full at 5 years. If you pay the mortgage over the full 30 years, you will pay $164,813.42 in interest. Check out these previous posts if you need a refresher on the amortization table or general mortgage concepts.
As a baseline, to pay off a $200,000 mortgage, even at zero percent interest, would require a monthly payment of $3,333.33. That would be purely paying principal. Since there is no way to avoid original loan amount actually borrowed, this is the minimal amount possible.
Monthly Pre-Payment Method – Paying this mortgage off in 5 years will require additional principal pre-payment every month of $2,715.23, or $3,728.60 total. The total interest paid will be $23,716.25, saving $141,097.17.
Annual Lump Sum Pre-Payment Method – Paying off this mortgage in 5 years will require an annual pre-payment of $32,000 on the first month of each year of the mortgage. The total interest paid will be $20,354.22, saving $144,459.20.
This chart shows how the principal balance on the mortgage declines over time with both the monthly pre-payment method and with the annual lump sum pre-payment method.
So far, it is looking like the annual pre-payment method is coming out ahead with $3,362.03 in additional savings.
Cost of the Annual Pre-Payment
The challenge is to get the annual pre-payment, which is the heart of the P.I.L.L method. This comes in the form of the HELOC or credit card.
Assume you take out a $32,000 HELOC, you will need to pay down the principal every month by $2666.67 in order to pay-off the loan by the end of the year and take out your next annual pre-payment. This means that any interest that accrues each month needs to be paid in addition to the principal reduction.
We are going to be as generous as possible with the P.I.L.L method assumptions and assume you get paid $7,000 on the first of every month. We will also assume all of your bills are due on the 30th, using 30 days for each month. That means on the first day of the HELOC you will owe $32,000, but on day 2, your balance will drop to $25,000, on the 30thyour balance when you pay your actual mortgage and all of the other bills will go back up to $29,333.33.
Each month, the starting balance will be your end balance from the previous month. It will continue to go up and down as you pay down the HELOC with your income. When pay your bills out of the HELOC it to go back up at the end of the month.
Over the course of a year, assuming the HELOC is at 7%, your total interest for the year will be $782.44. If you do this using a credit card at 20% interest, the total interest for the year will be $2,235.55.
Putting It All Together
Alright, so we have calculated all of the numbers, what does it look like when we compare apples to apples between just paying extra against principal each month versus using a P.I.L.L with either a HELOC or credit card?
We can take a look at the total cumulative interest over the course of the 5 year pay off period. While this graph is done with a $200,000 loan, the trends and curves remain the same regardless of the actual size of the mortgage.
As we can see, the monthly pre-payment ends up winning, with the HELOC P.I.L.L in close second and the credit card P.I.L.L as the big loser.
I can pay down my annual HELOC or credit card balance faster than the entire year.
Okay, great. That also means you can afford to pay more every month against your mortgage. Again, leaving monthly pre-payments the winner.
My home mortgage payment has a lot more interest being paid every month than against the HELOC.
True, but that is because it is interest against the entire remaining principal on the mortgage. When you take out a secondary form of credit the interest is against a much smaller principal. The annual pre-payment only reduces the interest on your monthly mortgage payment by the interest that would have accrued against the principal you paid off with the annual pre-payment.
The banks hate the guys who are pushing the P.I.L.L method, because it is costing them so much money.
Umm…right…because they told you the banks hate them? In the end, it costs you more in interest, just not on the home loan. They get their money back faster which they can turn around and re-lend. They really don’t care, unless they are benefiting from the extra interest you are paying on the HELOC or credit card.
The HELOC can provide me with emergency funds or if there is a month that I can’t afford to make the extra monthly pre-payment.
Then get a HELOC and leave it at a zero balance if you need a safety net. If you can’t afford to make the extra pre-payment on a particular month, then don’t. You can always make it up later or just pay off your mortgage one month later. Not a big deal in the grand scheme of things.
Netting It All Out
In the end, the P.I.L.L method is a complex scheme of borrowing from Peter to pay Paul, but at a higher interest rate.
There is no magic here. I really mean that, there is NO magic here.
The math is the math on this, don’t fall for some crazy complicated scheme that purports to optimize everything to save you a ton of money. It doesn’t work and actually goes in the other direction. It is all just hidden behind smoke and mirrors to make you think you are doing something other than just pre-paying your mortgage at a different frequency.
Many of these companies pushing the P.I.L.L method are doing it to make money off you. They sell you software for thousands of dollars or are getting millions of hits on a YouTube video for monetization purposes.
Finally, paying off your mortgage early is not hard in concept. It just takes discipline to live below your income and prioritize the extra monthly cash flow to paying off your mortgage. In this case, the simplest method really is the most effective, don’t make it harder than it has to be.
I’d love to hear your thoughts, please leave a comment below! Also, help get the message out about this shady method and share to your social media channels!