Tuesday, March 20, 2007

Mortgage Accelerator - paying off early

I heard an ad on the radio recently about a new mortgage product which allows you to pay your mortgage off early without doing anything different from what you're already doing - no extra payments, no biweekly payments.. nothing different.  My first thought was, "OK, what's the catch?"  And since I'm always on the lookout for a mortgage that might be better than a standard, 30-year, fixed-rate, fully amortized loan (and I haven't found one yet - for most people.), I wanted to do some digging & find out more about this product.

Well, it turns out the program might have some merit.  They created a mortgage which is a sort-of-combo mortgage/credit line/bank account.  It works like this.  You take out a mortgage on your purchase or refinance, and you can use any standard type of mortgage - in my case it would be a 30-year fixed rate fully amortized loan.  Then, once you have your mortgage in place, you use it as a bank account.  You write your checks from it, you have a debit card, you can direct deposit into it - everything a normal bank account does.

So where does the benefit come from?  You pay interest on your mortgage based on the balance of the loan outstanding.  In this case, the balance of your "bank account" offsets the balance of the mortgage, and you end up paying interest on your net account balance.  If you are the kind of person who keeps a lot of money in the bank, or who has a lot of cash flow each month, this could have a substantial effect on your mortgage.  Here's an example.

If you have a $350,000 mortgage at 6.5% (30 year, fixed rate, of course!), your monthly payment would be $2,212.24, principal and interest.  Over the course of 30 years (360 payments), you would pay a total of $796,405.71 (scary, but true.)  If you were to deposit $10,000 into your bank account on day one, you would only be paying interest on the net balance of $340,000.  However, your monthly payment wouldn't change, so more would go towards principal.  The net effect - you would end up paying off your loan in 331 payments, rather than the standard 360.  You would save 29 payments of $2,212.24, for a total savings of $64,155.  And you would still own & have access to your $10,000 deposit.  And if you carry a larger balance (or cash flow), your savings will be even greater.

In effect, your money is earning 6.5% (minus the percentage of your tax rate), instead of the 2% or 3% that your traditional bank might be paying you.  The upside is that some people will be able to save quite a bit of money without doing anything other than opening a new bank account.  The downside is that not everyone carries a large balance in their checking account, and if you have your money invested elsewhere you should be able to beat 6.5% (minus the tax rate) per year over a 30 year period.  But it is food for thought, and I'm sure some of you out there could take advantage of this!

-Chris