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The phrase “weird trick” seems to have great sales appeal,
judging from the frequency with which it appears in my
in-box. I see weird tricks for lowering blood pressure,
losing weight, improving sexual prowess, reversing diabetes,
and accelerating the pay-down of a mortgage balance. This
last group of tricks I hear about mainly from readers, who
have been told about the trick by friends, loan officers, or
internet hustlers.
Q: Will borrowing a larger amount than I need and repaying
the excess right after closing allow me to pay off my
mortgage early?
A: Yes, this trick works by generating a larger payment than
the one needed to amortize the balance over the term. For
example, if you need a 4% 30-year loan of $280,000 to
purchase your house but you borrow $300,000 instead and
immediately after closing you repay the additional $20,000,
your required monthly payment will increase from $1337 to
$1432. The larger payment results in payoff in 317 months
instead of 360, with a saving of $27,214 in interest.
But this trick imposes an unnecessary cost on the borrower.
Settlement costs that depend on the loan amount, including
points and origination fees, title insurance and per diem
interest will be calculated on $300,000 rather than
$280,000. In addition, because of the way that loan
servicing systems work, it is very likely that the borrower
will pay a full month’s interest on $300,000, even if
$20,000 is repaid the day after closing.
The alternative, which for most borrowers makes more sense,
is to borrow the $280,000 needed, and make a payment of
$1432 instead of the required $1337. You will pay off on the
same schedule as using the trick, enjoy the same reduction
in interest payments, while avoiding the increase in
settlement costs.
The only borrowers for whom the trick makes sense are those
who do not have the discipline needed to make a payment that
is consistently larger than the required payment. They need
to lock themselves into the larger payment, which the trick
does by making the larger payment obligatory rather than
discretionary.
Q: Will paying mortgage interest in advance shorten the
payoff period?
A: No, because there is no way to pay interest in advance.
Interest is calculated each month based on the balance at
the end of the preceding month. Interest is not known for
future months, since it depends on what happens to the
balances in the preceding months.
When you make a payment that is larger than the required
scheduled payment, there are only three things the lender
can do with the excess. First, they can accept it as payment
for any amounts owed to them. For example, if you owe them
for late fees, or if your escrow account requires
replenishment, they will probably use the excess for those
purposes.
The second thing they can do is apply the excess to the loan
balance, which will save on future interest and shorten the
period to payoff. Ordinarily, that is what the borrower
wants to happen.
The third thing the lender can do is assume that the
borrower is making scheduled payments early, which would
mean that the lender can invest the funds until they are
needed. There is seldom if ever a good reason for a
borrower to do this. The lender might nonetheless assume
that the borrower intends to make scheduled payments early
if the excess is an exact multiple of the scheduled payment.
If your monthly payment is $640.32 and you have extra money
that you want to use to reduce the loan balance, send any
amount except $1280.64, because that is exactly equal to two
scheduled payments.
Q: Is it true that the payoff period of a mortgage can be
cut in half if the borrower doubles the principal payment
each month?
A:
Yes, it is true. But last week I pointed out the formidable
downsides of this scheme, the most important of which is
that the required extra payment increases every month.
Hence, the only borrowers who are able to use it
successfully are those who can depend on a constantly rising
income.
Q: Is it true that a second lien HELOC or a (unsecured)
credit card can be used to pay down the balance on a first
mortgage well before term?
A: A number of
schemes (e.g., Mortgage Relief System, Tardus, Money Merge
Account) focus on exploiting the difference between mortgage
balances calculated only once a month and HELOC or credit
card balances that are calculated daily. For example, a
mortgage borrower who also has a HELOC uses all or most of
her paycheck to pay down the mortgage balance and funds
current expenses by drawing on the HELOC. If the interest
rates are the same, the interest charge on the HELOC,
because it is based on the average balance during the month,
will be only about half of the interest saving on the
mortgage.
The net
savings, however, are small unless the borrower also makes
additional loan repayments. Some borrowers may
find the tightly structured set of procedures provided by
these programs to be helpful in managing extra payments, but
to others they are a needless hassle.
