I was a bit skeptical when I read this article about high speed mortgage payoffs. What would they recommend to pay off your mortgage, I wondered?
Apparently, it's some ADB reduction plan on a daily compounded HELOC. A huge red flag went off when it said:
get a variable-rate, home equity line of credit (HELOC) instead of a fixed-rate loan for their first mortgageWoah, wait a minute. I should get a variable rate revolving loan instead of a traditional mortgage? How is that better?
So I read on, and the process sounds pretty simple, if it weren't ridiculously complex. You put all your paychecks into this loan, basically as a payment. Then you pay your bills with the loan. Well, that makes sense if you stick to a budget and make sure that you put more in than you take out. This part got me thinking:
When the account holder deposits a check, the debt immediately falls for a lower balance used to calculate interest. If the paycheck arrives on the first of the month, and the mortgage isn't due until the 28th, the balance falls by the size of the paycheck for all the days between.Well, that would work if my paychecks came in 2 times a week and all my bills are due at the end of the month. They aren't. They come throughout the month, so my paychecks mostly vanish as soon as they are cashed. My "average daily balance" in the loan, therefore (which is what they are talking about) really doesn't change all that much. As soon as the money goes in, it comes out for a bill. However I do see on large ticket items, like a mortgage that I need to set aside a little bit each week for, that this concept would work.
Then, I remember that this is a variable rate revolving loan. That alone kills the deal for me.
Here's the best part:
The loan is suitable only for borrowers who generally have more money coming in than going out, according to Kern Lewis, a marketing director for CMG Mortgage. Borrowers with negative cash flow would just keep adding to their debt.But why would I go out and sign up for this complex plan? Couldn't I just save my own money and pay extra towards my low fixed rate mortgage principle? Sounds a heck of a lot easier, and safer than messing with an enormous variable rate revolving loan.
Well, complex programs aside, they give an example of how this thing can help you, so I decided to compare it with just paying down your regular loan.
According to a CMG calculator, a borrower with a $200,000 mortgage, who takes home $2,000 every two weeks and saves 20 percent of net pay could be mortgage-free in 12 years using the accelerator compared with a conventional 30-year fixed rate loan. The interest would also drop by $125,000.Not enough info here, but okay. Basically you've got a $200k mortgage and you are putting 20% of a $4k monthly income to pay down the principle early.
On an ordinary 30 fixed at 6.5% you'd be looking at paying $225,000 in interest. So according to this article we can save $125k of that interest by paying it early with the rapid-accelerator plan. But if I took that 20%, which is $800 of that particular monthly income, and just apply it to the principle of my fixed every month, I end up only paying $84k in interest, so I'm saving $170k in interest.
We don't have a lot of numbers to work with, but $170k ballpark looks a lot better than $125k. And it doesn't involve taking out more loans or playing games with paychecks and bill payments. What this boils down to is saving 20% of your income and throwing it at your mortgage principle, which you don't need a fancy program to accomplish. So really, I have to ask, what's the point?
Both CMG and Macquarie said their businesses are increasing rapidly. But Gumbinger doubts they'll win a wide clientele. "Other mortgage products have come and died on these shores," he said. "Americans like the old, fixed-rate loans. Oh, we'll take an ARM if we have to but that's not what we prefer. High-end, sophisticated borrowers who are intent on quick amortization will probably support these mortgage accelerator products."Or maybe Americans can do math? Then again, if they make $4k a month and bought a $200k house, maybe they can't do math!
10 comments:
You've CLEARLY missed the point.
By using your income to reduce your principal balance upon deposit, you begin to save interest immediately. As for it being a "Variable Rate" program,by design, it offers you a hedge against increasing rates by lowering your balance with each deposit. Granted, the program performs more effectivly for those w/ positive cash-flow. Therefore, the CMG product is not the loan for everybody, but please do a little more homework on the program before you berate it.
And yes, while you may be able to compete with the performance of the CMG product by applying your extra $800.00 a month to your 30 yr fixed, Ask yourself, "Do I have the means and self discipline to consistantly apply that extra payment every month for next 180 months +/-?"
And "What if I need that money for some reason? With the CMG product, it's instantly avaiable! in the 30 yr, I have to apply for HELOC 2nd or refinance again to get that money (MY MONEY) back!" Thus, I HAVE TO PAY (MORE MONEY)TO GET MY MONEY BACK!
The CMG program is the most practical home and personal finance tool available to anyone with positive cash-flow and an interest in making their money REALLY work for them.
I'd really like to see some real numbers out of the CMG plan. From what I could see, just doing a few rough calculations, you come out FAR AHEAD by just paying consistently extra into your regular fixed loan.
There are a couple of flaws with your argument. First, you should have an emergency fund in CASH available to you if you "need money now". This emergency fund should be established before you start paying down on a loan. THEN you begin applying extra loan payments.
The very idea of using a HELOC as an emergency fund is idiotic. The idea of using a HELOC as a savings vehicle is idiotic. A HELOC is a LOAN!
You will be making your money "really work" for you by building a cash emergency fund and letting it earn interest for you, not by stashing it in a loan and lowering the interest you are paying to a bank, not by taking out a loan and paying it off early.
Again, I've love to see some hard numbers for this CMG program and compare it side by side with a traditional 30. I'm not saying the CMG doesn't work, I'm just saying I've seen no evidence that it works better than paying down a loan the old fashioned way.
On your advice, I did a little more research. Where better to find information about the CMG product than CMG's website? They have a handy calculator that shows me how much I can save with the home accelerator.
Apparently its broken. I put in a 200,000 principle to pay down with a 6.5% rate and that I save 20% of my income and compared it to a 30 year fixed rate. According to their calculator, with their program I pay the loan off in 29.6 years with an average APR of 7.73 and end up paying $320,621 in interest compared to the 30 year paying $243,316 in interest. I guess the calculator is broken?
Add that to the fact that with this program, your interest rate can change on a monthly basis, the margin on the loan is higher than the other idiotic product, the ARM, and there's an annual fee!
The more I research this product, the worse it gets. I look forward to hearing any counter arguments.
So it is user error. I ran the same calculations - 6.5% fixed for 30 years vs. running the simulator with a 2.5 margin (can be bought down to .75 margin!) and I get 12.5 years to pay off the loan. Even if I put $800 towards the principal, at 12.5 years, I've only paid $41,677 + $120,000 ($800/month) for a total of $161,677 with a remaining balance of $38,323. Total interest paid so far is $147,943. Remember, a 30 year fixed with additional payments only shortens the term. Unless it's an interest only loan where the payments are recalculated depending on the balance, the amortization tables show at month 150 total principal paid is $41,677 (add in the $800) and total interest paid is $147,943. Look at the LIBOR from 1990. The average is 4.43. If you buy down the margin, your average rate would be 5.18%. It would be better to take the $800 and place it into a mutual fund for better returns rather than a savings account. If you put the "emergency" fund into a savings account, what can you expect for returns and it's taxed. And why is it a bad idea to place your extra cash against your loan? If you have 24/7 access, POS access and check writing access, what's different than a savings account. You have a line amount, and you are building equity.
No, I believe the software is glitchy. I just entered the same information again (in fact, the program had apparently saved my prior data so I just clicked "next" until it recalculated), and now I'm getting 12.2 years paying $103,044 interest. That's saving 20% of my income.
Still, I put the numbers in a regular 30 year amortization schedule calculator and putting 20% of my income there I end up paying $83k in interest. I am coming out ahead with a 30 year fixed and my own prepayments, which I can do for free without annual fees and taking out more credit loans, every time.
I think you should try using bankrate.com's mortgage calculator. By putting $800 extra into the principle of a $200,000 30 year fixed you pay it off in 12 years. There is no "balance left over". It's paid off. When you pay down your principle on a regular mortgage, you pay it off early and save interest.
There is nothing wrong with putting extra cash into your loan so long as you are paying it off. But here when you need cash, instead of accessing YOUR assets, you're just going off and borrowing money again, and you're getting charged interest until you pay it back. Again, this is not an emergency fund, this is just access to credit. No different than throwing your emergency on a low rate credit card.
Your last one threw me for a loop. "what's different than a savings account" has to be a joke. The difference between a loan and a savings or investment account is pretty simple, in the first one the bank is making money, in the second one I am making it. I should borrow money to invest in the market?
You can't "build equity", only 2 things "increase your equity":
1) The value of your house increases.
2) You pay off the principle of any loan against the house.
You are right on one thing, that my $800 will be better in a mutual fund based on the average returns vs mortgage interest rates. But how, exactly, is the customer supposed to invest that $800 a month into a mutual fund when it is stashed into the HELOC? They'd have to borrow from the HELOC to invest in the mutual fund, which means their principle isn't being paid off faster so the entire program is pointless. Then you've got this variable rate loan socking you for interest at who-knows what rate.
The assumption with bankrate is that the additional principal payment changes the mix and the new payments are calculated by the reduced principal. Not true unless you have an I/O loan where the note states that the payment is recalcualted. If you take the traditional 30 year fixed, and run the amortization tables, the Truth in Lending document required by law shows that first month interest is $1083 and month 12 is $1072. Bankrate shows month 1 @ $1083 and month 12 @ $1023. Wrong! Unless the note states that the additional principal payment will cause the recalculation, additional payments will only shorten the term, not reduce the interest amount during that term. Read an actual note sometime. As for savings verses paying down principal, you're confusing liquidity to investment. I'm saying there is no difference between accessing the equity vs. accessing your savings. You earn very little for immediate access to cash and the Accelerator allows you the same 24/7 access. If you invest your money which you should, your access is impaired and not liquid. We treat investments different than savings when underwriting a loan. Also, 401K and such are only valued at 70%. Your problem with the simulator is a setting somewhere. I would ask for a live demonstration to clear up any questions.
And to further confuse the issue, if I go to year 11, first month, bankrate states that your interest payment is $188 and month 12 is $82. The Truth in Lending document provided at closing and required by law to be accurate shows at first month of year 11, $918 & month 12 is $897. So even though your principal has grown to $140,323 at the end of year 11, you're still short $59,677 because your additional principal payment did not change the ratio of interest to principal.
That's an interesting point if the schedule does not readjust. However, every calculator that I have found comes up with the same result. I find it unlikely that not one figures the prepayment the way you describe it. I also have been unable to find a single mention of this being true.
However that is very important, and I would like to see some kind of resource that verifies what you are saying; a resource that is not trying to sell alternative mortgage products, of course.
Thanks for the comments!
The resource I use is a LOS system which has all the tables. Additional payments depend on the note so you would have to read the note. Typical I/O loans will do what you think, but traditional 30 year do not. Like I said it's dependent on the note. For that matter you need to specify that you are making additional principal payments and not interest payments. It's the same as advertising rates - not everyone will qualify for those low rates. So if you have a traditional 30 year, go back to your note and look. And that is why the accelerator works - your overall interest expense is reduced because it's calculated on principal daily. If your loan calculates the interest monthly, then additional principal payments will have an impact.
I did a little research and found some information on how traditional mortgage calculations work. The gist of it is that each monthly payment you make is divided up between your interest payment and a payment to the principle. The interest payment that is made is based on 1/12 of the rate multiplied by the principle of the previous cycle.
My payment and rate is fixed, but my interest charge changes based on the balance. Anything left over out of my payment after the interest is taken is then applied to the principle.
If I apply more to my principle with an extra payment for that month, the interest is charged and then anything remaining (including my extra payment) is applied to the principle. Sometimes you need to specify this, sometimes you do not. I have spoken with my bank before about this and if I ever make a payment in excess of the regular payment the amount is automatically applied to the principle.
That payment would then reduce the amount of interest paid the next month, and so forth.
Everything I have read so far confirms my original understanding of how regular mortgages are calculated. Nothing says that the amortization schedule remains unchanged with additional principle payments. I thus assume that bankrate.com, as well as all the other calculators, are correct. I verified this at several different sources.
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