AssetBuilder - Registered Investment Advisor :: Simple Investing Smart Future

My wife and I (both 53) recently moved and, therefore, have bought a new home.  Our old home is currently still for sale but we are hoping not for long.  We were able to obtain what I believe to be a good deal on our new mortgage (5.75% fixed, 15 yr).  We were also fortunate (again, I believe) to be able to put down approx. 35% at closing.

Here's the setup: The same mortgage company that we secured the note through (who subsequently sold it to another party prior to the first payment being due) sent me an e-mail touting their "Home Ownership Accelerator" product (here's the link: http://www.citimacmortgage.com/homeownershipaccelerator).  It's basically a line of credit into which your paycheck is deposited and from which you pay your bills.  With some basic expenses information, I went through their simulator/calculator (http://www.cmgfs.com/home_loans/cmghome/calculator.html) and it indicated that we could pay off our mortgage in about 3 years - 12 years early!   With a corresponding substantial reduction in interest  being paid!

Now for the question: is this legit?  This is the first time we've heard of a program like this and, naturally, both my wife and I are skeptical.  The thought of being able to “get out from under a mortgage” sounds appealing, but…

What are we missing here?

JS in OK 

 The only way you can reduce a 15 year mortgage to 3 years is by paying a great deal more principal in a short period of time. If your mortgage is $100,000 that's what you have to pay back. You can cut the total interest burden by making extra payments of principal, but it's all about repayment of principal.

 The "magic" of the much touted bi-weekly mortgage programs isn't in making a payment every two weeks instead of every month. It's in making what amounts to 13 mortgage payments in a year instead of 12. The extra payment goes to principal and takes several years off the term of your mortgage.

 You can shorten your mortgage (or any loan) still further by making yet more in principal payments. Most people, however, don't earn enough income to take a home  mortgage down from 15 years to 3.

 Scott
 

Most of what you expound upon, I agree with.

However, I think you are missing the crux of the question posed here. 

You are correct in that most people do not have enough take home pay to pay down a mortgage much faster than 2-5 yrs.  We are fortunate enough that we do have a fair amount of “free cash” - at least at the moment.

My understanding of the program in question is that you are using a “line-of-credit” as your source of money for paying your normal monthly expenses in addition to any unexpected expenses.  Your initial expense is to pay off your existing mortgage; therefore, your home (up to 90% of appraised value for this program) is then used as collateral for establishing the line of credit.  Your paycheck is “deposited” into this line of credit – effectively making a payment towards the line of credit thus reducing the balance.  Over the course of time, you pay your expenses as usual but using the line of credit – this increases the balance.

Given that you are charged interest on the daily balance outstanding, and your average daily balance is substantially reduced by this method, you end up paying significantly less in interest.

Additionally, since the “free cash” (the difference between your take home pay and all of your expenses) that you have available is also being used to reduce your balance, you are reducing the life of the loan (line of credit).

So, how do you evaluate the use of this “free cash” for paying off your mortgage early from an investment perspective?  If you were able to garner a guaranteed (and we all know that there really is no such thing) return of 7% on your “free cash” and your interest rate on the line-of credit was, say, 8%, is it worthwhile?

     I repeat, there is no magic in this. It's all about how much additional money you commit to paying down your mortgage/line of credit. The online calculator sited, for instance, asks how much of your net paycheck you save, but the lowest amount allowed is 10 percent.

    Most people do most of their saving through their company plan and many people don't save enough to capture their full employer match. So saving a minimum of nearly 10 percent MORE (yes, it's after-tax 10 rather than pre-tax ten percent) is a big deal.

   You can see how big a deal by making some comparisons. Suppose you earn a good income and have $10,000 of takehome pay monthly. That's a total of $120,000 a year, of which you save 10 percent or $12,000. Suppose also that you are very conservative in your home buying and have just bought a house for $400,000 with a $300,000 mortgage at 6.25 percent. Your monthly mortgage payment would be $1,847 and you would pay the mortgage off in 30 years. You would also have a choice about what you did with the additional $1,000 a month. You could invest it elsewhere or you could add it to your mortgage payment and accelerate the paydown of the mortgage.

    My calculator says that the extra $1,000 a month would pay the mortgage off in 12.77 years.

    Now lets use the same monthly figures in their online calculator for THEIR line of credit loan which happens to have an APR of 7.72 percent. Again, when you take out their line-of-credit/mortgage you make a monthly payment of $1,847 and you also reduce the credit line by an additional $1,000 a month. Their online calculator says your loan would be paid off in 14.2 years instead of 30.

    Note the difference. Make additional principal payments on a conventional 30 year loan at 6.25 percent and you'll have it paid off in 12.77 years. Make additional principal payments on their higher interest rate line-of-credit loan and you'll pay the loan off in 14.2 years instead of 30.

   As I said earlier, the most important thing here is the amount of extra money applied to the loan each year. Everything else is window dressing, marketing and hits at magical results from your cash balances. If the amount of money available to be saved were smaller, the shortening of both mortgages would be much diminished.

    Yes, there is some advantage to using your full monthly cash flow to reduce the principal balance somewhat through each month. But this not that big a deal. Remember, the mortgage is $300,000 and the monthly cash flow is $10,000, of which $1000 goes permanently to loan reduction. So the interest you are saving on cash flow is whatever your cash balance is through the month--- some fraction of $9,000. It's a nice touch, but it doesn't appear to overcome the higher interest rate over a conventional fixed rate mortgage. 

 
Scott
 

Wow! I don't think you even bothered to understand this person's question or you don't understand how the interest is calculated on with this type of loan product. It simply requires less interest to be paid because the daily balance is lower than with a traditional mortgage.

 I have come across your information previously online and each time I believe your advice is lacking. I'm not sure what your net worth is or if you have it posted anywhere? I would certainly like to know what it is if you are advising others.

I went to the site the OP mentioned.  Found it long on hype and short on details. 

Rothchild, since you say Scott's answer is so lacking, how about you provide an analysis of these products.  Including the effects of any setup fees and how long it takes to recover them.  And the effect of a higher interest rate in the line-of-credit.  Tell us what prevents the financially naive from ending up paying off their loan more slowly than a conventional loan.  Inquiring minds want to know.

 Rothchild,

    The Achilles Heel of online forums is that some people tend to get personal. This is a place to be compassionate and factual. It is a place to to deal straight up with concrete circumstances. That's how people can help each other and that's what I did in my response. Yet suddenly you want to know my net worth? Get a grip. And before you write innuendos, do some math.

   I do understand how interest is calculated on this product and all other direct reduction loans. It is calculated on the daily balance outstanding. As a consequence, there is some benefit to having the balanced reduced by the temporary excess cash implicit in having your full paycheck deposited to the mortgage account.

   In the big picture, however, that extra cash flow (and temporary balance reduction) plays a very small role in mortgage acceleration. The big time reduction comes from making significant and permanent principal payments. If you doubt this, please read the original column again.

 http://assetbuilder.com/blogs/scott_burns/archive/2007/10/26/the-magic-of-a-tricky-mortgage.aspx

Scott