The following article is a summary from Chapter 1 of Realtor for Life, written by Duane Duggan.
BOULDER – In the final stage of buying a home, while sitting at the closing table, it is always a bit of a joke when the happy home buyers are asked to sign the loan disclosures showing how much interest they will pay over the life of their 30-year loan. Oftentimes they say things like “Oh, I’ll be dead by then anyway”, or “Wow, I had no idea!”.
Closing on your home creates a perfect opportunity to put a system in place to build equity and real estate wealth by applying mortgage acceleration techniques. The ideas about mortgage acceleration have changed many times over the years. The Depression-era generation celebrated mortgage-burning parties when the final payment was made. The following generation kept mortgage balances high for tax deductibility and in theory, “invested” the cash for a better return. Then came the next generation, with home values skyrocketing, they used their homes as cash machines, pulling cash out for consumer items and lengthening the term of their loan, and in theory, never paying off their mortgage. This resulted with many losing their homes to foreclosure. So which generation is the smartest? The answer is not so simple. It takes quite a bit of study to figure it out.
What if you or your clients had no mortgage on your property? Would life be any different? Could you invest that cash flow that would have gone into mortgage payments into something else? There are many ways to accelerate the payoff of a mortgage and there are just as many considerations as to whether or not to pay one off early at all.
The graph below shows the structure of how a 30-year amortized loan works if no mortgage acceleration techniques are applied.
Mortgage acceleration techniques
1. Create your own amortization schedule to pay it off in the desired number of years. On a $100,000 Loan at 6% you could pay the loan off according to the following schedule:
2. Bi-weekly mortgage payments program. The way that this program works is that when you make a payment every two weeks when you get a pay check, you put enough in so that it would be equivalent to making one extra payment a year. This program will usually pay off a 30-year mortgage about 7 years sooner. Some lenders offer a bi-weekly mortgage payment plan. You can call your lender to see if they offer a bi-weekly plan. Some lenders will offer the program for free. If your lender doesn’t offer a program, there are third-party companies that can set up a program for a fee.
3. One extra payment a year program. On a bi-weekly program it is about the same as making one extra payment a year. So what about just making that extra payment once a year? You can do that and accomplish about the same thing without having to pay for or set up a bi-weekly program.
4. Mortgage acceleration programs, such as the one utilized by a company called United First Financial, uses the first mortgage that is in place on a home, a home equity line of credit, and what is called money merge account software. This program utilizes a line of credit like a primary checking account. An important function of this line of credit is what is called an open-end interest calculation. By putting your monthly paycheck towards paying down the line of credit balance, it keeps the balance that interest is calculated on low. By keeping the balance lower, more of the monthly payment is attributed to principal rather than interest. The program helps you manage your money and tells you when would be the best time to make a lump sum payment toward your mortgage principal. These programs are expensive and there are claims that you can easily set up a similar system by yourself. You can check out information on this program at unitedfirstfinancial.com.
ARGUMENTS FOR NOT PAYING OFF YOUR MORTGAGE EARLY
Since mortgage interest is deductible many will argue that you want to keep your balance high to keep your interest deduction up. From the graph above, it shows the first year interest to be $5,967. If you were in the 30% tax bracket, your tax savings would be $1,790. If you actually invest the tax savings, that is an argument for keeping the balance high.
Time value of money
If inflation were 4% a year for the next 30 years, the value of a dollar 30 years from now would be about 30 cents. The argument being that you are paying off a dollar with only 30 cents. However, if you had no mortgage payment and you safely invested that amount each month, it softens the time value argument.
In summary, everyone needs to decide for themselves if they want to get their mortgage paid off or keep their balance high. Everyone’s situation is a little different, so it is a good idea to consult their individual advisors and generate their own set of goals.
Duane Duggan has been a Realtor® for RE/MAX of Boulder in Colorado since 1978 and has facilitated over 2,500 transactions over his career, the vast majority from repeat and referred clients. He has been awarded
two of the highest honors bestowed by RE/MAX International: the Lifetime Achievement Award and the Circle of Legends Award. Living the life of a Realtor and being immersed in real estate lead to the inception of his book, Realtor for Life. For questions, e-mail Duane at [email protected] or call 303.441.5611.