Pay off your home mortgage early and you'll save yourself a bundle in future interest charges. Add $50 to your monthly mortgage check this summer and you'll own your house free and clear in 15 years. Send in half your regular monthly mortgage payment twice every month and presto, you'll save tens of thousands of dollars in loan interest charges over the next 19 years, pain-free.
Those are just three of the promotional come-ons for what could become a fast-growing trend in the American mortgage market. Early-loan-pay-off plans sponsored by lenders are proliferating in markets across the country. That's not necessarily a negative development, either, provided consumers understand precisely what they're getting into and at what cost.
The Mortgage Bankers Association of America, for example, has done some calculations of savings that new home buyers in 1985 can rack up by using the latest loan wrinkle -- the so-called biweekly mortgage plan. First developed in Canada and now available from major lenders in several parts of the United States, the biweekly plan works like this:
Instead of sending in the 12 monthly principal and interest payments a year that are standard with the traditional 30-year, fixed-rate mortgage, the biweekly mortgage is paid in 26 installments a year, and typically comes with a term of 18 or 19 years.
A conventional 12 percent, 30-year mortgage of $75,000, for instance, requires principal and interest payments of $771.46 a month, including $202,725 worth of interest over the full 30-year term.
A biweekly version of the same $75,000 mortgage at 12 percent, by contrast, requires $391.53 in principal and interest payments every 15 days, but only $108,236 in total interest charges over its 18-year term -- a hefty $94,489 savings over the 30-year model.
That's pretty attractive, you may say. After all, for just a fraction more in total payments each month and year -- in effect, the equivalent of 13 monthly installments a year versus 12 -- we can pay the entire house off in roughly 60 percent of the regular time, and save a bundle to boot.
But not so fast. There's more to early-payoff plans than meets many consumers' eyes at first glance.
An excellent, computer-assisted analysis of the early-pay concept has been prepared by Don Clifton, a Spokane, Wash.-based Century 21 Realtor and investment counselor. Writing in the June issue of the Real Estate Advisor, Clifton argues that paying a little extra each month will be great for your lender, but not necessarily a shrewd economic move for you.
Take the case of a $60,000 fixed-rate, 30-year mortgage at 12 percent. Its standard monthly principal and interest payment comes to $617.17. How about increasing that payment $60 a month? Chipping in the extra cash every 30 days will help to cut the loan term down to just 18 1/4 years. But it will also raise the effective interest yield on your mortgage to your lender to 13 1/3 percent.
What's so bad about that -- particularly because nearly 12 years are being lopped off your mortgage debt? Potentially plenty, says Clifton: You're handing dollars to your lender today that could be invested and earning more for you in the aggregate than you'll save in the coming years by paying off your mortgage prematurely.
Why not invest the extra $60 a month in a profitable way, rather than giving it to a lender who plans to do the same? For example, if you put the $60 a month into an investment that yields an average of 15 percent for 18 and 14 years, you'd have $69,015.62 at the end of the term, Clifton notes. By then, it would be earning you interest at a rate sufficient to use just part of your earnings to pay your regular mortgage bill, and to pocket the rest.
According to Clifton's calculations, from year 18 until the final mortgage payoff date 12 years later you could leave your $69,015.62 earnings alone, pay off the mortgage and still have $58,946.46 to spend on whatever you want in the meantime.
That, he argues, is a far preferable use of your extra dollars over the course of your home mortgage than handing it over in monthly dollops to your beloved mortgage lender. Of course, you can quibble with some of Clifton's calculations. For example, how many homeowners today can count on 15 percent returns on investments? Clifton responded by asserting that, even with considerably lower returns, his central point is valid: You often can do better investing your extra cash yourself rather than handing it over early.
But what about 15 percent? As a real estate investor, "I can consider 15 percent the bare minimum acceptable yield on my dollars," Clifton said. Wise homeowners can do well with mutual funds and a variety of other investments, but Clifton personally prefers discounted mortgage notes -- locally originated, seller-financed second mortgages -- that regularly yield him between 18 and 30 percent a year.