This series of articles is about opportunities available to
consumers to save money on a mortgage in 2013. The first 2
articles were directed to
This Is a Good Time to Pay Down Your Mortgage
One of the
vexing features of the post-crisis financial system is the
dearth of riskless investments paying a decent return. The
rates on Federal Government securities and insured CDs are
not much greater than zero. Yet every homeowner with a
mortgage has the opportunity to earn a return equal to the
interest rate on the mortgage, with no risk, simply by
making extra payments. It is the best investment opportunity
most homeowners have.
The only
downside to using mortgage repayment as an investment is
that it has no liquidity – once you make the payment you
can’t take it back if you have an unexpected need for funds.
However,
Confusion About Loan Repayment as an Investment
Some borrowers
have trouble viewing mortgage repayment as equivalent to
buying a bond or a CD. Yet in both cases, you pay out money
now and receive a stream of income in the future based on
the contracted interest rate. The only difference is that
the income received from a mortgage repayment is
cancellation of interest that you would have had to pay
otherwise. The difference between receiving $1,000 of
interest, and eliminating the payment of $1,000 of interest,
is one of form but not of substance.
Those with a mortgage can actually earn a little more than
the interest rate on their mortgage by taking advantage of
the 10-15 day payment grace period that is found in all
mortgage contracts. By adding the extra payment to the
scheduled payment, the borrower will save interest for the
entire month, even though they do not provide the funds
until 10 or 15 days into the month.
Note: if they make a separate payment after the grace
period, their loan balance may not be reduced until the
following month, which would reduce their return on
investment.
Confusion Over Deductibility
Some borrowers who itemize their tax deductions don’t want
to repay their mortgage because it entails loss of a
deduction. But the loss is exactly the same as that on a
taxable investment. For example, a borrower in the 33% tax
bracket who repays a 3% mortgage earns 2% after tax. If
instead, the borrower purchased a CD paying 1%, the
after-tax return is 0.67%. If the before-tax rate on the
repaid mortgage is above the before-tax rate on the
alternative investment, the same will be the case after
taxes.
Confusion Over Mortgage Life Cycle
Some borrowers believe that they missed the boat on loan
repayment because they didn’t do it
in the early years
of their mortgage when the regular payment went largely to
interest, whereas now most of it goes to principal. But the
rate of return on mortgage investment is not affected
by where the mortgage is in its life cycle. While the
allocation of scheduled payments between principal and
interest changes over the life of the mortgage, extra
payments go entirely to principal, no matter what stage of
its life cycle the mortgage is in.
Confusion Over Imminent Sale or Retirement
Some borrowers are immobilized by plans to sell the home, as
if somehow this would prevent their obtaining the expected
benefit from making extra payments. But it wouldn’t, in fact
the benefit would become glaringly evident in the smaller
loan balance they have to pay off out of the sale proceeds.
A similar point applies to those planning to retire with
reduced income. If and when they need a reverse mortgage in
the future, they will have to pay off their existing
mortgage in the process, and the lower the balance, the more
they will be able to draw on the reverse mortgage.
Confusion Over Whether the Lender Will Properly Credit Their Account
Numerous versions have crossed my desk, including a concern
that the lender won’t credit their account until the end of
the term. This is not true, the account is credited
immediately or even a few days early, as noted above.
A variant is that the lender will use the extra payments for
some purpose other than reducing the loan balance. The only
substance to this concern is that the lender will indeed
apply extra payments to any unpaid obligations, of which the
most likely is an underfunded tax/insurance escrow account.
Aside from that, the only thing the lender can do with extra
payments, other than credit them to the loan balance, is to
steal them, which they never do.
With one exception, borrowers making
extra payments need not provide special instructions as to
how the payments should be applied. The exception applies
when the extra payment is an exact multiple of the scheduled
payment – the payment the borrower is obliged to make each
month. If the scheduled payment is $600 and the borrower
sends in a check for $1200, the lender does not know whether
the borrower wants to apply the extra $600 to principal, or
is paying for two months. To avoid this problem, do not make
extra payments an exact multiple of the scheduled payment.
