A question that comes in frequently - and came in again this morning - is "How can my home equity line of credit help save on mortgage interest when the HELOC interest rate is higher than the mortgage interest rate?"

That is an excellent question, and one of the kernels in the cob of financial literacy. To get ahead financially, you need either a lot of luck, or to understand how interest is calculated. The question gets to the root of compound interest. There's more to it than I can cover in one short blog post, so I'll simplify the answers over the next several posts.

QUICK! Which is heavier, a pound of feathers or a pound of lead?

We hear "feathers" and think of something light. We hear "lead" and think of something heavy - the substance Superman can't see through! Intellectually, however, we know that a pound is a pound - unless it's coffee, which is now 12 ounces! My point is: What something seems to be and what it really is can be as far apart as feathers and lead.

For the most part, mortgage interest is calculated monthly and compounded monthly. (There are "simple interest" mortgages that are compounded daily, but they are not common in the United States.) On a mortgage that is compounded monthly, payments to principal do not affect the current month's interest. Making an extra payment to principal this month will not affect (reduce) the interest owed until next month.

HELOC interest is calculated daily. Any payments to the principal owed this month reduce the amount of interest accruing this current month.

More in the next post.

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