Never buy biweekly baloney

After closing a mortgage, some lenders go back to their borrowers to extract even more money. Preying on their borrowers' inability to perform compound interest calculations, these lenders promise to prepare a new early payoff system that will permit their borrowers to save thousands in interest—for a small fee of just $395. Under these plans you pay 50 percent of your scheduled monthly payment 26 times a year (biweekly) instead of the full payment 12 times a year.

Mortgage Secrets calls this type of scam biweekly baloney, not because you can't profit by prepaying your mortgage. You can. Rather, it's because you need not pay your lender (or some other soliciting company) a fee to do so. Unless your mortgage includes a prepayment penalty, you can pay any time you want in any extra amount(s) you choose.

How to Achieve an Early Payoff

Your lender (or your mortgage servicing company) wants you to believe that setting up a new payment schedule and processing all of those biweekly payments deserves an extra administrative fee. It doesn't. You can write a check for your scheduled monthly payment; then enclose another check for $500 (or whatever amount you choose). Through a written note, tell the lender to apply that extra amount to principal.

Financial Tables, $29.95 Calculator, or Web Sites

Under the biweekly plan, you (in effect) pay one extra monthly payment per year. That prepay slices the term of a 30-year, fixed-rate mortgage down to about 22.5 years. Under the payment system proposed by Mortgage Secrets, you can create the same result by dividing your regular monthly payment by 12, then using that amount to supplement your monthly checks.

If you want to pay more or less than one-twelfth of your regular payment, you can easily calculate how quickly your loan will pay off and how much interest you will save. Nearly all major bookstores stock books that show compound interest tables. Simply multiply or divide the appropriate numbers, and you can evaluate the results of any proposed schedule of prepayments. (Note: Buy compound interest tables that show the interest rate factors, not precalculated mortgage payment books.)

Although some people still rely on a book of compound interest tables, most others use either a financial calculator (which you can buy at an office supply store for $29.95 or less), or the mortgage calculators available on web sites such as hsh.com, bankrate.com, and mtgprofessor.com). Even modest prepay sums regularly made will save you years of mortgage payments and tens of thousands of dollars in interest.

Should You Prepay?

Lenders report that several million Americans regularly prepay their 30-year mortgages. Many of these people are not saving as much money as they could (Secret #15). Rather than regularly prepay their 30-year loans, these homeowners should refi into a shorter-term mortgage. In addition to achieving early payoff, they could save big dollars in interest each year because 15-year loans typically (though not in periods of flat yield curves) charge a lower interest rate than 30-year loans. On a $400,000 loan the lower interest rate could save the borrowers $1,000 to $2,000 per year— unless interest rates have turned against you, that is, the current refi interest rate for 15-year loans equals or exceeds the rate you now pay for your existing 30-year loan. Of course, if market rates now sit lower than your existing rate, your 15-year loan could really put dollars in the bank account as well as equity into your home.

Qualifying and Flexibility. You might prefer a 30-year loan because you believe it's easier to qualify for a 30-year loan. That's true only if you borrow similar amounts. But as Secret #15 shows, if qualifying presents a problem, reduce the amount you borrow. A less expensive property financed for 15 years can build equity faster than a more expensive property financed for 30 years.

You might choose to combine prepay and a 30-year loan because you want flexibility. "Yes, we're prepaying now, but if times get tough, we want the flexibility to cut back." That's not unreasonable. But, remember, "flexibility" costs you a steep price. Instead, you might use an interest only loan to achieve this same objective.

Loss of a Tax Deduction. Some advisers argue against prepayment and, for 30-year loans, recommend keeping the tax deduction for interest as high as possible. In responding to a published query, financial planner Marty David urged a homeowner couple (both age 52) to dump their 15-year mortgage that's now within 8 years of payoff in favor of a new 30-year loan. "I would recommend refinancing and getting a 30-year fixed mortgage," said David. "This insures that you will be paying mostly interest for the first 10 years, and get the largest tax benefits of mortgage interest. Think of it this way: The federal government has promised to pay you 30 percent of any interest payment you make (assuming you're in a 30 percent tax bracket). If you reduce your [total] interest payments, then the checks from the government will stop coming sooner."

Folks, that's precisely the wrong way to think about it. Yet, I repeatedly see this misguided view. These people are 52 years old! They need to build as much wealth as possible now. To correctly address their dilemma, one need only calculate how much their net worth will differ in 10 years. Using the financial planner's approach, the couple will be far poorer than if they had stayed with a shorter-term mortgage (see Secret #15).

They may have paid less in income taxes, but never try to minimize taxes perse. Tax-shelter promoters lure many investors into financial ruin while baiting their hooks with that appealing promise. Rather than minimize taxes, maximize after-tax wealth.6 Regrettably, investors and financial advisers alike confuse these two very different—and often conflicting— objectives. Shorten the term of your mortgage through prepay if it enhances your net worth. Forget trying to minimize taxes as a goal separate from building wealth.

Alternative Investments. Ultimately, your decision to prepay turns on whether you can earn a higher risk-adjusted rate of return on your investments. Throughout the 1990s, investment writers said, "Leverage the house to the hilt and put the cash into stocks." Essentially, the prepay issue revisits the pros and cons discussed in Secret #86. Fairly considered, stocks, bonds, and rental properties do typically offer a riskier use of home

6The wealthiest 10 percent of all Americans pay more than 80 percent of total IRS income tax collections.

equity funds; however, when choosing between home equity, rental properties, stocks, or bonds, Mortgage Secrets recommends that wealth builders choose investment properties—as long as you retain a cushion of home equity and cash reserves. For wealth preservers—that is, for those people who have accumulated the wealth and security they need—Mortgage Secrets recommends prepay.

SECRET # 103

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