What would you say if you could save $26,257 by investing your pocket change?
Sound like a scam?
Not if you are a homeowner with a mortgage.
By investing $25 a month, or 83 cents a day, you'll save $26,257 in interest costs on an 8.50 percent, 30-year mortgage loan of $100,000.
That's what Linda T. Gebelein, 35, of Baltimore wishes she had known 10 years ago when she and her husband bought their first house with a mortgage at a whopping 14 percent rate. When they sold two years later, they had almost no equity. That -- plus a real estate agent telling them they should have prepaid an extra small amount of principal each month -- taught them a lesson, says Mrs. Gebelein. Now, she says, they make an extra principal payment every month. "We regard it as a form of savings," she said.
"Everyone blows $25 a month, everybody has $25 in a cookie jar or a penny jar," says Marc Eisenson of Elizaville, N.Y., and author of The Banker's Secret, a do-it-yourself guide to prepaying all types of debt, particularly home mortgages. "If you get into the habit of managing debt, your mortgage is a good place to invest." Yet few homeowners do prepay, according to a rough estimate by the Washington, D.C.-based Mortgage Bankers Association, a trade association. Though it has no hard data, the association estimates that about 5 percent to 10 percent of homeowners prepay, a number its researchers believe has stayed relatively static.
Prepaying your mortgage is simple -- as long as you write the check to pay your mortgage, you can prepay your mortgage. In fact, many lenders have made the process easier in recent years by adding a line to payment coupons for extra payments toward principal.
Middle school teacher Barbara K. Hall of Montgomery County was 38 when she and her husband bought their dream home in Spencerville three years ago. She knew she did not want to be paying her mortgage into retirement, so she cut down the term of her loan and began prepaying the principal. Last August, Ms. Hall and her husband refinanced their loan, trading their 9.25 percent 30-year mortgage for a 15-year loan at 7.25 percent. They now add $200 a month toward the principal. That, she says, will pay off their mortgage in 12 years and two months and save her and her husband $22,500 in interest payments.
While everyone agrees that paying $25 or $50 a month extra toward the mortgage is a fine investment, making more hefty payments may not be wise, says Robert F. Hines of Chesapeake Financial Planning and Tax Services in Annapolis. Borrowers should consider the tax benefit of their mortgage interest deduction -- and the impact paying it down would have -- on their income tax bill. They also need to consider how much of a strain an extra payment will put on their budgets and whether that money could bring a higher return elsewhere.
"It depends on the age of the client, how close to retirement, the type of mortgage they have, how much time is left on it, and the interest rate," Mr. Hines said. "If you are in a high tax bracket, and there is a strong likelihood of staying in a high tax bracket and your income staying stable, then you may not want to prepay." Instead, he said, borrowers may want to invest the money they would prepay into a higher-return investment. That allows them to keep the tax deduction from mortgage interest payments as long as possible.
Such arguments do not convince Mr. Eisenson. On the advice of his brother Sam, Mr. Eisenson paid off his first house in five years. Freeing himself from that mortgage made all the difference in his life, he said. "Being debt-free meant that I didn't have to keep chasing my tail to earn money . . . And it allowed me to semi-retire when I was 30 years old."
He believes borrowers should view paying off their debt as another type of low-risk investment.
Homeowners who want to pay their mortgages off early can handle it themselves, or turn to specialists for advice or a range of services. At the low end, for instance, Mr. Eisenson, for instance, sells his book, The Banker's Secret, and its companion computer program, for $42.95 with shipping. (The book costs $14.95 separately.)
But some companies offer packaged plans -- such as the Split Payment Mortgage System and the Biweekly Mortgage Acceptance Corp. service -- that cost $400 to $500, a lifetime fee that is portable with mortgages.
According to these two companies -- and there are similar offers from other companies -- they will electronically transfer money from the borrower's bank account biweekly to pay the mortgage. The benefit, say the companies, is that the borrower makes one extra mortgage payment per year. These companies also audit the lender's record of the borrower's mortgage payments and adjustable rate mortgage calculations to make sure the account was properly credited. The companies sell their service directly and through financial planners who receive a commission.
"It is safe to say that the discipline afforded by the program coupled with payment accuracy monitoring is a very very sought-after service," Jeffrey B. Brown, director of marketing for Bedford, N.H.-based BiWeekly Mortgage Acceptance Corporation, said. "You can lose weight on your own, but there wouldn't be $1.9 billion weight-loss industry if they could and did do that. And simply making the payment does not ensure that calculations are done correctly."
L But does the average home borrower need these $400 services?
"I've heard of them, but I don't use them and I don't recommend my clients use them," said Donald L. Lebowitz, certified financial planner and president/owner of Lebowitz & Associates, Ltd. in Baltimore. "It's relatively expensive for the work they have to do and they can have a bank do it without a fee or stay on top of it themselves."
Sun real estate columnist Michael Gisriel, who is also senior vice president at Fountain Head Title Group, says he has been dealing with prepayment companies for over 20 years. "Most people don't have the discipline or the follow-through to [prepay]." And that is what these companies provide, he said, at a reasonable cost if you consider the interest you will save.
"On the other hand, if you have the ability and time to call your own lender and work out your payments, you can do it yourself," he added.
Mr. Gisriel said that if you are considering using such a service, ask for references and find out how long the company has been in business. He also said to consider companies tied to larger lending or well-known institutions.
IF YOU WANT TO PREPAY
Prepaying your home mortgage simply means adding additional money to mortgage checks and telling the lender to apply it to your principal. Following these tips, culled from financial planners, mortgage bankers and other experts, should make dealing with your lender and tracking your mortgage easier:
* If your bank does not have a prepayment line on your mortgage coupon, add a note telling the lender to apply the extra amount -- including how much -- toward principal. Adding the note is important, said Brian Chappelle, staff vice president of the Mortgage Bankers Association in Washington, D.C., because lenders will generally apply any extra amount first to your escrow account, then to interest and only last to principal.
* If you do not have an amortization schedule from your bank, get it. An amortization schedule shows how much of each monthly payment applies to principal and how much to interest over the life of the loan.
Payment statements from mortgage lenders also will help you track your mortgage. A statement tells you how much of your payment the bank applied to escrow, interest and principal. Lenders furnish statements on different schedules -- annually, bi-annually, quarterly or monthly. Lenders may charge a fee to issue more frequent statements or for running new amortization schedules.
* Keep records of your extra payments. Making regular prepayments of the same amount will make tracking your interest savings easier.
* If you are considering a 15-year mortgage, think it over. You can pay off a 30-year mortgage in half the time by following a 15-year amortization schedule. And you have the option of lowering your payment to the 30-year level if you run into financial trouble.