New ways to pay the mortgage
Making extra payments against your mortgage is a time-tested way to pay off your house early and can save an enormous amount of interest over the life of a typical home loan.
With 80 to 90 percent of initial mortgage payments going to pay interest charges, it takes about 10 years of a 30-year loan before most borrowers start to really chip away at their loan balance. By sending in even modest additional payments early in the loan, homeowners can build equity much faster.
But most people don't have a lot of extra cash lying around. Even if they do, they want to keep it for emergencies rather than tie it up until they sell or refinance their house.
These days, some consumers are getting around that dilemma by moving their monthly income and expenses through home equity lines of credit and credit cards, a strategy that allows them to pay down their mortgages faster without having to find more income or cut back on spending. And a plethora of new home equity products coming onto the market is making the process a little easier.
In August, CMG Mortgage, a mortgage broker and banker in San Ramon, is taking the next step by offering a mortgage that promises to put to work money that would otherwise sit in low-interest checking or savings accounts to pay down principal, in some cases shortening the term of a 30-year loan by 10 years or more.
Financial experts say the concept works well for some people who have positive cash flow and don't carry credit card balances. But with interest rates on their way up, it may become less appealing for homeowners to use adjustable home equity lines to pay down mortgages that have low fixed rates.
Pam Narz, a city worker in Westminster (Orange County), is a disciplined spender and saver who used a low-interest home equity line and the grace period on her credit cards to reduce her mortgage balance by about $35,000 in the past year. She now expects to pay off the mortgage, which has 26 years left on it, in slightly more than seven years, saving $120,000 in interest charges.
Her strategy? She used $20,000 from her 4 percent home equity line of credit to pay down her 7 percent first mortgage. Her house payment remains the same, but now a bigger share of it goes toward principal, or paying down the loan, and much less goes to interest.
Most of Narz's paycheck is sent electronically to her home equity line of credit account. During the month, she uses her credit card to pay for as many expenses as possible. When the bill comes due, she pays it off in full with a check from the equity line.
Average balance is lower
The result is that interest is calculated on a lower average loan balance during the month. In Narz's case, she also has a positive cash flow of about $1,600 a month, which is also used to pay off the equity line, so her $20,000 balance disappeared in about a year. She then repeated the process with another $20,000 transfer from the equity line to her first mortgage.
"I still do the same things I've always done. I just pay for them in a different way,'' said Narz, who started using the system a little more than year ago after she bought instructions from a company called Tardus America, which sells its package of materials for $495.
Implementing the strategy doesn't necessarily require the Tardus materials, but it helped explain the process well enough that she felt comfortable with using it.
"The hardest part is just wrapping your mind around the concept,'' Narz said.
She acknowledges that the strategy doesn't make sense for people who carry credit card balances, aren't disciplined or who don't have much cash flow. The strategy could be a dangerous temptation for people who tend to run up their available credit.
"You can get into trouble if you're not careful,'' Narz said.
As home equity lines become increasingly flexible and cheaper to set up, it's becoming easier for consumers to implement strategies similar to Narz's.
Washington Mutual, for instance, offers a hybrid product, On the House Advantage 1st, that can be used for both refinances and purchases.
This home loan takes the place of a traditional first mortgage. Instead, it acts like a home equity line of credit. As borrowers pay the principal and build equity, they can write checks against that equity.
Borrowers may link their checking account to the mortgage account and transfer as much money as they want into the mortgage account whenever they want to pay down the balance. When they need to use the money, they simply write a check or use the ATM card that comes with the account.
Helpful for first-time buyers
According to Sara Gaugl, a spokeswoman for the bank, this type of mortgage makes sense for first-time home buyers who may want the option of making an interest-only payment at the outset and for people who work on commission and have less-predictable incomes.
"Borrowers have the ability to control their finances. They can take advantage of a low interest payment, or they can pay toward the principal balance of their home,'' she said in an e-mail.
The new product from CMG Mortgage takes the concept a step further, consolidating the equity line with a checking account so that money flows in and out seamlessly. The Home Equity Manager, as it is called, is similar to mortgages already popular in Australia and New Zealand, where homeowners don't get tax breaks for mortgage interest, making them eager to pay off their loans as soon as possible.
The Equity Manager is a first mortgage meant for both purchases and refinances, covering up to 75 percent of a home's value.
Borrowers have their paychecks deposited automatically into the account. That income is immediately applied against the principal loan balance, reducing the amount of interest charged for the month.
As checks that the account holder has written clear, the amounts are deducted from the equity. The interest due that month is also deducted.
The account also comes with an ATM card.
Depending on how much money flows through the account each month, the results can be dramatic, said Christopher George, CMG's chief executive officer.
CMG calculates that a borrower with take-home pay of $5,000 per month and total expenses of $4,000 per month could pay off a $300,000 Equity Manager loan in 13.2 years, saving more than $200,000 in interest costs compared with a traditional 6 percent fixed-rate 30-year mortgage. The calculations assume a 4 percent starting rate that rises one percentage point a year and tops out at 8 percent.
Of course, if a borrower simply sent in $1,000 per month extra to the lender on a traditional mortgage, he'd get essentially the same results. But CMG's marketing manager, Doug Nesbit, argues that juggling the family books each month to maximize the amount of money applied to the mortgage without bouncing checks is tricky and too complicated for most people.
The second advantage is that borrowers can access the money at any time by writing a check. With a traditional mortgage, any extra loan payments are tied up until the home is sold or refinanced.
Strategy not for everyone
The loan makes sense only for people who carry a significant balance in their checking account or who accumulate money for weeks in anticipation of a large expense, such as property taxes or tuition, George said.
The CMG loan or strategies such as Narz's could also work wonders for people who follow the advice of financial planers by keeping six months' worth of expenses in a low-interest liquid account in case of an emergency or sudden job loss.
George sees his company's new loan as a way for consumers to enjoy the same benefits on their idle money that now flow to the banks' bottom lines.
"Why should the bank get the credit for my money?" asked George. "The consumer isn't going to stay this docile and obedient forever. At some point, the consumer is going to say, 'I want greater efficiency with my money.' "
Scott Bilker, author of several books on mortgages and debt and founder of the Web site DebtSmart.com, said the CMG loan could be a great option for people who are strategic with their money.
"It's definitely a cool option,'' Bilker said. "The savvy borrower is going to throw as much toward this as they possibly can. It's yours whenever you need it, and when you don't, it's earning you whatever (interest rate) you would have paid on the mortgage.''
Bilker said he won't be working to pay down his own 4.75 fixed-rate mortgage because interest rates are almost sure to rise. But for borrowers who missed the boat on the very low rates, it might make more sense.
David Yeske, who runs the San Francisco financial planning firm Yeske and Co. and chairs the national Financial Planning Association, said many people don't have enough extra money in their accounts to make significant dents in their loan balance. For them, such strategies are likely to yield only modest benefits.
The main downside, he said, is the interest rate risk common to any kind of adjustable mortgage.
"As recently as 2001, the prime rate has been as high as 9 percent,'' Yeske said. "If you had a chance to lock in a 6 percent fixed rate, you would be so much better off than taking a chance on a 4 percent variable rate based on prime.''
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