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Accelerate or Bust?
Q: Could you explain the mortgage accelerator programs that purportedly will save you a big bundle of interest without much outlay because you pay off your mortgage in five, seven or 10 years?
A: Let’s imagine that you owe $250,000, have a 6-percent interest rate and that the mortgage has a 30-year term. Your monthly cost for principal and interest would be $1,498.88 and your total potential interest bill over three decades would be $289,596.80.
Let’s also say you get a pay raise and that starting from month No. 1 you add an additional $200 with your payment. Now the loan will be repaid in 267 months (22.25 years) and the total potential interest bill will fall to $203,486.15.
You can see the concept here: If you have a fixed-rate loan and pay more per month then the length of the loan gets shorter. With less principal outstanding over time the interest bill falls. Pay enough extra per month and you can get the loan term down to seven years or five years. For example, with the loan above you would have to pay $2,921.71 per month for principal and interest to repay the debt in seven years.
Whether it makes sense to accelerate a mortgage depends on your finances and personal preferences. The major points to consider include:
• Can you make prepayments without penalty? Even loans with penalties during the first few years often allow small prepayments. In the best case you want the ability to make prepayments in whole or in part without penalty and at any time.
• What if you move or refinance in less than 30 years? If you pay off the loan in 10 years rather than 30 you’re still ahead because you owe less to the lender at closing.
• What are your other debts? If you have credit card debts you might well do better paying down such bills because of the higher interest costs.
• What are your savings? In a world where layoffs and downsizing are too common, you need savings.
The idea of loan acceleration is well known and hardly new: I have been writing about it since the 1970s and can assure you that I did not “invent” the concept. What’s new and different, however, is that every few years someone comes along and wants to tweak the basic concept.
For instance, one idea is to take every dollar in your checking account at the end of the month and to use that money to increase your loan payment the next month. My concern with this approach is that it may not provide adequate cash savings for emergencies.
Another idea is to make your payments bi-weekly. Most loan servicers are simply not equipped to handle bi-weekly payments, so ask if they would accept 14 additional checks per year. Get your answer in writing.
Given that there are 52 weeks in a year you would make 26 bi-weekly payments instead of 12 monthly payments with such programs. Rather than write a lot of extra checks, an easier approach is to make prepayments – after all, 26 half payments are simply equal to 13 full payments. Pay a little more each month and you can get the same result as with a bi-monthly system.
Of course, we have a lot of third-party entrepreneurs and helpers who can assist with the prepayment process. For a set-up fee and a fee per payment they will handle the whole process if you send your checks to them. This strikes me as a woefully bad idea because the money spent for fees could be better spent for principal reductions. No less important, third-parties are not your lender. If they make a late payment – or no payment – it is your credit that will suffer and your home that could be foreclosed.
It used to be that lenders were opposed to mortgage prepayments but most now see that with prepayments they have less risk. Mortgage payment coupons today routinely have a space where you can add money to reduce your principal.
For specifics, speak with your lender. The odds are that you can start your own prepayment program at no cost by just filling in your payment stub.
Peter G. Miller is the author of The Common-Sense Mortgage and a veteran real estate columnist. Have a question? Please write to email@example.com.View Foreclosure Article Archives
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