Q. I have a new mortgage loan of $328,000 at 5.25 percent. Recently a direct mail offer said that if I pay the mortgage biweekly, I can save about $100,000 during the loan repayment period. Can I pay one additional installment every year directly to the mortgage company and have the same advantage as biweekly installments? What is your recommendation for this?
I am also getting letters for mortgage insurance. The companies say that in case of my death, the remaining loan would be paid off by a life insurance policy I can buy.
Please let me know how to decide whether to go for such things or not. ----P.R., by email
A. If you followed this plan, you would save less than $100,000. My calculator puts the savings at about $71,429. If we also considered the purchasing power of the money repaid and some loss in tax savings (because you’ll pay $71,429 less in tax-deductible interest), the saving in real purchasing power would be still less.
That doesn’t mean you should not work on paying your mortgage off early. It just means some of those dollars are apples and others are oranges.
There is no reason for you to pay a third party to help you pay your mortgage off early. You can do it for free, in your spare time at home. Offers like the biweekly offer you received come with virtually every new mortgage or refinancing. The offer makes it sound as though there was great magic in making biweekly payments. That’s simply untrue.
The magic is in paying extra principal each year.
Here’s how it works. When you make biweekly payments, you make 26 payments a year for one-half of your stated mortgage payment. That means you make the equivalent of 13 normal mortgage payments a year, not 12. That single extra payment accelerates the pay down of principal. Over time, it reduces the number of payments you will make.
If you read the fine print carefully, you’ll find that while YOU will make 26 payments a year, this third party won’t. They’ll make your normal payments and, in the course of each year, they will make a single additional payment.
So calling it a biweekly mortgage plan is simply a marketing gimmick.
If you would like to pay your mortgage off early, try this. Divide your $1,811 monthly mortgage payment by 12. Add that amount ($151) to your regular payment. Your new payment will be $1,962 each month. At the end of a year you will have made the equivalent of 13 regular payments, just like the magical biweekly mortgage. Instead of paying $652,042 over the life of the loan, including $334,042 in interest, you’ll be paying $590,613 over the life of the loan, including $262,613 in interest. You’ll be on your way to saving $71,429 in interest over the 301-month life of the mortgage.
Want to shorten the life of the mortgage still more? Make the equivalent of two extra monthly payments a year by paying $2,013 a month. You’ll have your mortgage paid off in 286 payments. The real magic is in additional payments of principal.
Before buying mortgage insurance, shop for a term life insurance policy. It is likely to provide you with greater benefits for a smaller premium outlay.
Q. In 2010, I will be taking monthly distributions from my federal Thrift Savings Plan and annual distributions from my Vanguard Long-Term Treasury Fund. I want to reinvest these distributions for emergency purposes or as an inheritance for my son. What are some good investment options?---W.R.
A. Try this two-step plan. Build an emergency fund, limiting it to three to six months of current spending. Step two would be to use additional money to build a portfolio that both you and your son would like, probably a balanced fund that would be about 60/40 equities/fixed-income. You’ll be close to that with most of the Couch Potato Building Block portfolios that you can learn about on my website (www.assetbuilder.com). Alternatively, you could invest in one of the many no-load, low-expense balanced funds that I regularly mention in this column--- such as Vanguard Balanced Index (ticker:VBINX).