Quick -- what's the most expensive thing you'll ever buy? Your house? Close, but it's probably not the house itself that tops the list. If you borrow to buy your home, as most people do, the mortgage itself is the biggest cost item.
Because home buyers tend to focus primarily on the monthly payment, little attention is paid to the aggregate interest costs of the mortgage. Perhaps that's just as well, because they can be breathtaking.
Suppose you buy a $125,000 house and borrow $100,000 at 10.25 percent for 30 years. That mortgage, if paid off over the full term, will cost you $222,596 in interest -- double the amount you borrowed and almost double the price of your house. And that's in addition to the $100,000 in principal that you have to pay back.
Traditionally these costs have been made less burdensome by the tax code. Before tax revision, an upper-income homeowner could save 50 cents of every interest dollar through writeoffs on his or her federal income tax return. State tax deductions added to the savings, particularly in high-tax jurisdictions like the District.
In addition, periodic spasms of inflation have further eased the pain. Anyone who bought a house in 1958 and is making his or her last mortgage payment this year will probably be happy to tell you how ridiculously low that payment will be by today's standards.
But tax revision has made the deduction less valuable, in effect reducing the government subsidy, and inflation no longer shrinks payments as rapidly as it once did.
As a result, a growing number of home buyers and homeowners are casting about for ways to cut their interest costs.
"People are looking to manage their debt in a somewhat more aggressive manner, perhaps to manage their liabilities as aggressively as they have managed their assets" in the past, said Dennis Campbell, vice president for marketing at the Federal National Mortgage Association.
Fifteen-year mortgages offer one avenue: They usually carry slightly lower rates, and their shorter term further reduces lifetime interest costs. However, they lock the borrower into a higher payment schedule that may place an unacceptable strain on the family budget.
Adjustable-rate mortgages offer lower rates, at least at first, and most come with restrictions -- "caps" -- that protect borrowers against sudden interest rate runups. But these loans do carry risks. If rates go up and stay up for several years, the mortgage's rate will catch up, with potentially painful results for the borrower.
A surprisingly effective alternative is to make what is called voluntary payments of principal. Systematically overpaying your mortgage by even a modest amount each month will shorten its life significantly and cut the total interest costs.
Calculations done by the research department of Fannie Mae show that paying an extra $25 a month on a $100,000, 10.25 percent, 30-year mortgage would knock a little more than four years off the loan's lifespan and save the borrower $38,659 in interest. Overpaying by $100 a month has a truly dramatic effect. The savings on that same $100,000 mortgage amount to $94,401 and the term drops to slightly more than 19 years.
There are other variations that produce similar results. Fannie Mae's figures show that making a 13th monthly payment each year and having the lender apply it to the principal balance (the amount remaining on the loan) saves $77,881 and cuts the term to 21 years.
Similarly, there is the biweekly mortgage, under which the borrowers make a payment every two weeks instead of once a month. Because paying every two weeks results in 26 payments a year, the results closely resemble those of a 13th monthly payment: savings of $81,263 and a term of 20 years, nine months.
None of these plans raises the borrower's annual outlays very much. The regular monthly payment on the $100,000, 10.25 percent mortgage is $896, adding up to $10,753 a year. That is plenty stiff for most people, but adding $25 a month boosts that annual total by $300, to $11,053.
An extra $100 a month would push the payment to $996 and the annual total to $11,953.
Similar savings can be realized with other mortgage amounts and terms. Fannie Mae, which recently began buying biweekly mortgages, figures that a borrower of a biweekly $70,000 mortgage at 10.5 percent would save $60,000 over the life of the loan, compared with a conventional payment schedule.
In fact, because of the way loan-payoff schedules are calculated, extra payments or biweekly mortgages pay off even faster at higher interest rates.
"Rapid paydowns give people the ability to manage debt better than a slower amortizing loan," Campbell said. " ... You're really putting money in the bank" with the speedier payoff, "building up equity in your home."
This is equity that can be tapped later with a home-equity loan or home improvement loan, if needed, he noted.
"In the past you built up equity but you couldn't get at it. Now we have developed the means to get at it easily," Campbell said.
However, enticing as these savings may seem, some home finance experts warn that borrowers should consider all the angles before embarking on an accelerated payment plan.
"Remember, your mortgage is probably the cheapest loan you're ever going to get," said Warren Lasko, executive vice president of the Mortgage Bankers Association of America. He noted that it is likely to be cheaper than a car loan or any other consumer loan, and unlike those remains tax deductible.
So homeowners would be well-advised to examine their financial needs carefully before hastening to pay off their mortgages, Lasko said. If they are going to need the money -- for the children's college tuition or for medical costs, for example -- they might be better off putting their extra payments into some form of savings. Pulling the equity back out later could be more expensive if rates rise.
"Keep the cheap money while you've got it," Lasko said.
In addition, the homeowner is "making a guess about future inflation and interest rates," Lasko noted. An increase in either would reduce the benefit of early repayment.
If inflation takes off, future mortgage payments will be made with cheaper dollars, benefiting the borrower.
If interest rates rise, the homeowner may want to hang on to his below-market loan. Indeed, if rates rise enough, the homeowner may be able to find bonds or certificates of deposit at higher rates than his mortgage.
And if interest rates plunge, the homeowner can refinance. It is these characteristics that led former presidential adviser Martin Feldstein to call the fixed-rate mortgage "a peculiar sort of one-sided gamble" that is loaded in the borrower's favor.
But there can also be good reasons for accelerating the payoff. For example, a middle-aged borrower who wants to be debt-free at retirement can use this technique to achieve that goal.
Lasko also said he "remains skeptical of the biweekly mortgage" as a way of reducing debt because it commits the borrower to make the payments even if conditions change. With voluntary extra payments, "you are in the driver's seat" and can stop them anytime.
Fannie Mae's Campbell agreed that voluntary payments are "a very viable alternative to taking a shorter-term mortgage." But he pointed to the discipline factor in the biweekly or 15-year loan that compels the borrower to make his payments and not fritter the money away on other things. "I'm afraid we're dealing with human nature," he said.