I've done a lot of "heavy thinking" about mortgages over the last couple of months - always looking for a type of loan which might be better for my clients than a standard, 30-year fixed rate mortgage, but also skeptical that I wouldn't find one. This has probably been too much writing about too boring of a topic, so this will be my last post on the subject for awhile (at least until a more exciting mortgage catches my eye!) But I did want to take a minute to follow-up on something I wrote about last month.
I wrote about a new mortgage product last month, and I thought it had some potential. But the more I think about it, the less I like it. The program involves getting a new mortgage for your home - any type of mortgage is ok (although I strongly recommend a standard, no-frills, 30 year fixed rate loan). Then, you open a bank account with the same company, and the balances are added together; you get credit for keeping money in your bank account, and pay mortgage interest on a reduced amount. The concept is that you don't need to do anything differently, but you end up saving money.
Here's the problem: Most people don't carry large bank balances. Let's look at an example of a person with a $200,000 loan, who keeps an average monthly balance in his bank account of $2,500. Here's what the results could look like:
Standard Program: Loan Amount = $200,000; Interest Rate = 6.75%; Term = 360 Months; Payment = $1,297; Total Paid = $466,920.
Mortgage Accelerator Program: Loan Amount = $200,000; Interest Rate = 6.75%; Term = 360 Months; Payment = $1,297; Bank Account Balance = $2,500; Loan Paid Off in 346 Months; Total Paid = 448,762; Savings of $18,158*.
Standard Program w/ Principal Reduction: The numbers would be identical to the Mortgage Accelerator Program if you took the $2,500 in your bank account and made a one-time principal reduction payment on your loan balance. Of course, you would no longer have access to the $2,500 for other purposes. On the other hand, if you did use the $2,500 for other purposes, it would no longer be working to reduce your total loan payments.
* Note that this savings is the cumulative savings over a 30-year period. Also, since mortgage interest is tax deductible, the savings would be reduced by the amount of additional taxes you would pay.
The only scenario where it is really useful, where you don't have to do ANYTHING different (pay down balance, keep money you don't use, etc.) is if you run a large amount of cash through your account each month. You can then continue to use your money without worrying about the consequences to your mortgage, and your average balance will be high enough to offset some of the mortgage interest. But in reality, people who run $20k through their account each month, with an average balance of $8k or $10k, probably have more than a $200k mortgage. And then the results are the same as above - it's not much more than a drop in the bucket.
If the program is free, great - go ahead & save some money. But if you have to buy any software, or pay any fees to open the account, I would think long and hard before taking action. You're going to tie up your money anyway; might as well just pay down the mortgage balance and get the same benefit.
Upon further review, the standard, no frills, 30 year, fixed rate, fully amortized mortgage is the best loan available for 90% of people out there.