The Savings Game

Speed up the mortgage payments and save, but beware of gimmicky strategies

Email|Print|Single Page| Text size + By Humberto Cruz
November 21, 2006

When my wife, Georgina, and I paid off our $100,000 mortgage early 19 years ago, we saved $97,468.70 in interest.

We did it simply by enclosing a second check -- everything we could afford -- with our regular mortgage payment each month. Along with this check, we sent instructions to use the extra money to pay down the mortgage principal.

This is basic math. The less principal you owe on a loan, the less interest you are charged as part of each regular payment. As a result, more of each payment goes to further reduce the principal balance. If your goal is to pay off your mortgage early (we are not saying it should be for everyone) you can do as we did, without having to fall for gimmicky strategies that overstate your savings or hide your cost.

And there are plenty out there.

"Would you like to pay off your mortgage in 15 or even 10 years without having to change your current lifestyle?" begins a typical pitch. Although details vary, the basic idea is to turn your mortgage into a "cash-flow management account" that works like a bank.

You do it by depositing your entire paycheck and any other income you receive "into" the mortgage -- that is, into the cash-flow management account. All deposits reduce the outstanding balance on your loan. As you need money to spend and make withdrawals from the account, the loan balance goes back up.

The concept is intriguing, and the setup convenient. The companies promoting these programs typically offer free online bill paying and free debit/automated teller machine cards as easy ways to make withdrawals, in addition to unlimited paper checks.

The math, too, would seem to work. If you are depositing more than you are taking out and doing so regularly, you stand to save more in interest than if you simply send extra payments to the principal from time to time.

And by having your paycheck deposited directly into these accounts, you create an element of discipline and forced savings that's lacking when you must remember -- and decide -- to send extra payments to principal on your own.

Problem is, the marketing literature is often misleading, comparing apples and oranges and enticing the homeowner to refinance by taking on a home-equity line of credit that provides for the unlimited checking, bill-paying, and ATM access. By sleight-of-hand, this line of credit, with a higher interest rate than the mortgage, is made out to be a savings move.

For example, one of these programs boasts that a homeowner paying 6.5 percent interest on a 30-year, $300,000 mortgage could have the mortgage paid off in 15 1/2 years by using a cash-flow management account tied to a variable-rate home equity line of credit charging 7.72 percent to start. To realize the same interest savings made possible by the early payoff, the homeowner would have to find a 30-year mortgage charging a mere 3.83 percent, the marketing claims.

In reality, what makes the early mortgage payoff possible is not the line of credit but the assumption that this homeowner would save $800 a month into the cash flow management account. So, why not simply keep the existing mortgage at 6.5 percent and send an extra $800 into the principal each month?

Then, "the result would be paying off the mortgage in 14 years and three months," or 15 months earlier, said David B. Jacobs, a fee-only certified financial planner in Kailua, Hawaii. And the homeowner would save an additional $45,000 in interest over the life of the loan, compared to the line of credit, Jacobs said.

Besides the line-of-credit costs, a one-time fee for setting up and managing these cash-flow accounts can run as high as 1 percent of the loan balance. If you were to apply to the mortgage principal the fees saved by not using one of these services you could reduce your mortgage payoff time by another year, Jacobs said.

And yet, "people whom I would normally consider fairly financially savvy are falling under the spell of this marketing blitz," he said. "These schemes take the simple idea of making extra payments toward your principal and make it look more complicated so they can charge for what you could simply accomplish on your own."

Humberto Cruz is a columnist for the South Florida Sun-Sentinel.

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