There’s a new kind of mortgage, and it’s taking the refinance world by storm. The promoters of this new kind of loan claim that you can pay it off in full in eight years without changing your budget at all! This sounds like it would be ideal for any homeowner. Let’s take a look at this mortgage and see if we can figure out if it is really all its cracked up to be.
This new kind of mortgage is commonly referred to by many different names, but because its purpose is to accelerate the paying off of a mortgage, we will refer to it as an accelerating mortgage. This accelerating mortgage makes use of compounded daily interest, instead of, monthly interest. It also makes use of the fact that the borrower and co-borrower deposit their entire paychecks into a mortgage account each time they get paid. Then, they actually use their mortgage account as their checking account and pay their regular monthly expenses by writing checks against the mortgage account. The process of depositing money into the mortgage account before using it for everyday expenses saves interest because of the daily compounding used by the accelerating plan.
What the advertisers for this mortgage don’t mention is, in order to pay off the mortgage very quickly, like in 8 years or so, each month you need to leave more money in the mortgage account than the amount the regular 30-year mortgage payment would be. The mortgage writer or broker will refer to this as your monthly savings and ask if you put aside 10, 15, 20, 25 or more percent for your savings on a monthly basis. The amount you tell him will be the extra amount you will be expected to leave in your mortgage account each month.
I see three problems with this type of mortgage financing. First, the majority of people close on their new houses in a tapped out condition. They save for years to accumulate their down payments and then they buy the most expensive houses they are able to make payments on. To them, their savings is the equity in their houses.
Second, if you have the ability to pay in an extra 10, 15, 20 or 25 or more percent of your salary toward any mortgage, you will pay it off a whole lot sooner than 30 years. For instance, it will take 30 years to pay a $200,000 mortgage at 6% if you are paying the scheduled monthly amount of $1199. 10, but if you add $800 to this payment each month, your mortgage will be paid in 11 and one-half years.
It is true, that when comparing an accelerating mortgage with a regular 30-year fixed mortgage, that has the same parameters (principal, interest and term); the accelerating mortgage will reach 0 more quickly than the 30-year mortgage will. However, it would be a matter of several months sooner, not 22 years as some of the advertisements for the accelerating mortgage would lead you to believe.
So, what’s wrong with paying the same amount into a mortgage account, and still getting it paid off sooner? Nothing! But here’s problem number three: an accelerating mortgage uses a HELOC. (Home Equity Line of Credit) there are some things you should know about HELOCs. First their interest rates are usually higher than a conventional 30-year mortgage interest rate. Second, they are adjustable-rate mortgages. On top of that, they have no cap and they adjust every month. What this means is that if you find a fixed rate 30-year mortgage at six percent, you know that in four years that mortgage’s interest rate will be six percent. With a HELOC, you may find one at six percent but in four years you could be paying thirteen percent. So much for paying your mortgage quickly, because as you know, when interest rates rise, so does the monthly payment.
We are now in a time in American history, where interest rates are relatively low. With inflation under control, it looks as though interest rates are trending downward. It may well be that the current interest rate downtrend will continue well into 2008 when it will test the post-1960’s low of 4. 75 percent. After that, you never know what the future will bring.
In January 2009, the U. S. will be inaugurating a new president. Many of the candidates running for the high office would like to reverse the free trade policies of the last three presidents. These free trade policies have in large part, brought us the robust economy along with the low interest rates we have enjoyed since the mid ’90s. These candidates also want to end the George Bush tax cuts. These tax cuts have had a tendency to cancel the inflationary effects of higher oil product prices. Some of these candidates also want to institute national health-care. It has been proven that private industry is more efficient than government run entities. Private industry money gets reinvested and creates more money. When money goes to the government as in government run health-care, it is being sent down a one-way dead-end street. This is a very inflationary scenario, and inflation means high interest rates.
Not long ago, I wrote an article about biweekly mortgages. In this article, I called the biweekly plan a scam. I don’t feel the same way about the accelerating plan. I think the accelerating plan is creative and in true mathematical terms, it would pay your mortgage off a little sooner than a regular mortgage, if rates stayed flat. The problem is, at least, the way I see it, there is a potentially unstable interest rate environment on the horizon. I also see some of the promotions for this mortgage as misleading and this makes me worry. Throw in the fact that I have never known anyone to institute an accelerating plan and then pay it off in the prescribed short term, and this makes me see the accelerating plan as speculative. Therefore, I’ve got to believe that for the time being, a fixed-rate mortgage is the best way to go.