Home mortgage reduction kit

The National Home Mortgage Reduction Kit

Some common mythos and flawed arguments relating to mortgage financing, mortgage prepayments or acceleration

There are some pockets of people - mostly mortgage lenders and real estate sales people - who insist that speeding up the mortgage repayment is an unwise financial idea. Such persons have been largely able to sustain their arguments against speedier loan repayment based on some polular myths.

Lets outline the major arguments by people who argue against everything from paying down the mortgage more speedily, to investing in real estate relative to other types of investments, and explore the merits of such arguments, if any. Lets also examine the underlying purposes and motivations that oftern undergird such myths and arguments for those who frequently champion them.

The Principal Myths and Arguments

Myth#1 The Purchase Price of the Home is the true “cost” of the property

This is false. In reality, it is the amount of INTEREST you pay on the house financing over the years that more significantly represent the actual TOTAL cost of the property.

Myth#2 Equity in a home is built mainly from increases in market value, due to demand for housing

This is a common attitude and assumption among many. The assumption is, the build-up of equity in a home comes about as a somewhat natural and automatic result of increased market value, combined with the gradual repayment of the mortgage loan. Many assume that housing is invariably a sound and profitable investment, and that housing prices would inevitably climb upwards over the years as a result of greater demand and increased equity in the property, and hence if you were to buy a house today and sell it 10 or even 5 years from today, you would almost surely sell it at a profit. With others, the assumption is common that major home improvements in a property will inevitably translate into a rise in the house’s value and equity.

This attitude - which is dubbed the “passive” approach - is not only untrue but also often costly for the homeowner, as it invariably results in the mortgage lender earning a greater profit on the home than the homeowner or seller. True, home values increase as a result of demand, and housing prices in your area may well climb upwards. But there is no guarantee of that. Increased demand is only one factor among many different variables which, together, combine to determine future value. Many other market and economic factors - the location of your home, the cost and level of care and maintenance you and your neighbors put into the property, the trends in crime rates or employment in the area, the state of the national economy or of your state’s or region’s economy, etc - have a great deal to do, as well, in determining the future value and equity for a house. And while home improvements made in one’s property is almost always a sound investment, the assumption that your house’s value and equity will rise dramatically or automatically as a result of that, is not always a safe one. While home values may increase over time as a result of demand and market forces, there are simply no guarantees that this will necessarily happen with your property. The amount of equity you build in your home as a result of market conditions and home improvements, is simply both limited and uncertain. In any event, ultimately you are at the mercy of prevailing market and economic conditions and will have little control over the demand for or price of your property.

Even if the equity and market value of your home were to substantially increase, there still will remain another important question. The question of WHO WILL PROFIT FROM THE INCREASE? One way of finding an answer to this question is by comparing the historical changes in housing prices to the cost of buying and borrowing. A homeowner’s equity in a home builds up through reducing the mortgage debt on the house. But, for a house involving the typical 30-year mortgage term, that kind of equity typically accumulates very slowly in the early years of the repayment term, in that in the early years of a mortgage, each payment consists almost entirely of interest and it is only as time goes on that you begin to pay more of the principal and less of the interest until, toward the end when your payments become mostly principal. Hence, for the homeowner, realistically the likelihood of having a substantial profit is low when you sell after only 5 to 10 years. Furthermore, even if the market value of the property increases considerably over the years that you own your home, the interest you pay your mortgage lender will offset that market value and hence, you will wind up making much less profit from buying the home than the lender makes, as much of that increased value is converted to profits not for you, but for the lender.

Housing experts have observed that, no matter how much home improvements homesellers make on their houses to make them more attractive to potential buyers, the maximum sale price they obtain is often limited still, in that buyers are frequently not willing to pay a price substantially above that of comparable homes and such homes will usually not sell for an amount equal to the total cost of improvements just because you have added some value to the property.

Myth#3 You are better off paying full interest on your mortgage rather than to accelerate payment, in that acceleration reduces the tax benefits of mortgage interest deduction

However, that is not quite so. It is true that mortgage interest is generally fully tax-deductable and you do reduce itemized deductions quite alright by accelerating your mortgage payments. However, this deduction is offset by the greater savings you make in overall costs. The fact is that, even with the reduced deductions of your mortgage interest expenses on your tax return, you will still come out much farther ahead in the interest savings you make by accelerating, relative to what you lose by not taking the full itemized deductions (or what you would have gained if you had taken the full deduction).

Furthermore, for a lot of people, the tax deduction doesn’t mean very much. According to experts who have made the calculation, depending your tax bracket, each $1 of mortgage interest may be worth only 15 or 28 cents in tax savings to you. Worse still, experts say, sometimes the interest deductability will be utterly useless. Because your mortgage interest deduction and other itemized deductions, combined, may amount to less than the “standard deduction”. As a solid evidence of this, it is pointed out that indeed over 70% of all tax filers take the “standard”, not the “itemized” deduction, an amount which is set by IRS each year for a couple filing jointly.

Myth#4 Having a fixed-rate mortgage protects you from inflation, anyway

As one argument against acceleration, it is contended by some that, if you have a fixed rate mortgage, you need not be concerned anyway about the cost of interest in that your fixed rate mortgage should protect you against inflation.

That is not so at all. What is true is this: that inflation makes buying a home a good investment in comparison to paying rent. What is not true though is this: that that, therefore, makes mortgage acceleration a bad or unprofitable idea. From the standpoint of comparing the value of renting versus owning a home, it is generally a fact that one will make out better in terms of inflation by buying rather than renting, since it is generally agreed that, as the market value and the demand for homes or apartments increase over the years as a result of inflation, the renter’s costs of housing will likely go up as the landlord raises rents to reflect such increases in market value and housing demand. It is agreed that a buyer who finances a home with a fixed rate mortgage benefits from inflation in the same way in for him, the housing cost decreases over time (through the fixed payments and increased buying power), at the same time that the average income will likely grow by at least the same rate of inflation.

In other words, in assessing the renting-versus-owning question, the impact of inflation is felt in two ways. And each of them is just as significant and should be equally evaluated. First, the buying power of the dollar is eroded as prices climb. At 2% inflation, it is estimated that $1 Today will buy only $0.82 worth of goods in 10 years. Second, the cost of goods raises due to inflation. At 2% increase, an item that costs $1 Today will cost $1.22 in 10 years. And when both methods of evaluating the cost of inflation is used, it is found that the renter suffers heavily due to inflation, while the homeowner benefits. The renter, on the one hand, must pay ever increasing amounts of housing costs, while on the other hand the homeowner enjoys reducing costs over time through fixed payments and increased buying power.

Example one: A renter pays $600 per month for an apartment. He had average rent increases that match inflation at the rate of 2% per year. 10 years later, the same apartment costs him $732 per month.

Example 2: A buyer who has a family monthly income of $3,000 makes mortgage payments of $702 per month, which represents 23.4% of the monthly income. 10 years later, the total income, keeping pace with inflation of 2% per year, has risen to $3,600. At that point, his housing costs are 19.2% of his income.

Clearly, there is no question that inflation hurts the renter, while it benefits the homeowner and that buying a home is a good investment in comparison to renting. But that is where the myth comes into play. The stated argument, namely, the inflation factor argument, is only a strong one in supporting of investing in YOUR own home. It is an argument between the renter and the homeowner, not between the homeowner and the lender. It is, in other words, a completely separate issue. Certainly, you gain some financial benefits (call it profits) from being a homeowner relative to having to rent. But after you have secured those benefits, you still come back to the question of the total cost to you: How fast can you build equity in the property given the total interest costs you will have to pay the mortgage lender and the proportion of the total profits (it is less) that ultimately go to the homeowner relative to the lender.

In sum, mortgage acceleration still makes financial sense even with the fact that you get fixed costs when you buy a home when you consider the actual cost of buying a home versus the reduction in that cost, which you can bring about through payment acceleration, and when you consider the fact that interest would still erode in the lenders favor those profits you stand to make from renting as opposed to owning. This fact becomes even clearer from the comparison of housing values to interest cost.

Example: If we assume that annual inflation is 2%, the total rate of cost per dollar in 30 years is $1.81. That means that, assuming that the housing values keep pace with inflation, your $100,000 home will be worth $181,000 in 30 years. At the same time, for the $80,000 mortgage you took out on the home at 10% interest (that is after a 20% down payment you shall have made on the house), you will pay $252,742 in interest in 30 years. In other words, your housing costs (what you will pay and expect to spend on the house) as a homeowner would have exceeded the rate of inflation (what you expect to get back on the house) by some $71,742. Note that, using the rate of cost per dollar, you will find that, in order for real estate values to match your housing costs, which is only the break even point, they’ll have to raise by more than 3%, rate equal to 150% of inflation - quite a daunting feat.

Hence, we see that, even with the protection afforded by a fixed rate of interest, inflation will erode your gains to the point where you may not really have any net profit at all.

Myth#5 You earn more mony investing somewhere else in something else

It is often stated by financial advisors and investment salespersons that you stand to earn more money by putting the money you invest in making extra mortgage payments in other types of investments. This argument is couched in several ways: that you are better off paying off the home mortgage over the full duration of the mortgage term and thus investing that extra “disposable income” elsewhere; or, that with respect to the equity you accumulate in your home, it is financially foolish and imprudent to leave such huge “idle equity” just sitting in your home and should rather be taken out and be “put to work” in other types of investment; or that building up equity in a home is merely an emblem of poor financial manangement and that sophisticated financial management calls for you to indulge in “leverage” requiring that you always be in debt to the maximum level you can attain.

Such propositions are badly flawed. Use of financial leverage (debt or borrowed funds) for investment opportunities which, presumably, may yield better returns, may be a sound financial strategy. But the reality is that leverage is not without cost, it can be an expensive and risky strategy. As one analyst plainly sums it up, “The more you owe, the more you repay, and the longer you will remain in debt.” Sure, in given cases, it is possible you could exceed, by way of profit, the percentage you pay on your mortgage by investing in some other types of investment. But at what risks? The moment you factor in the risk element into the calculation of yield, and properly compare both the yield and the risk involved, you will immediately find that there are probably not many other comparable investment options in terms of yield and risk, and that as a general proposition, your home is most likely the safest and surest investment available to you.

Consider the issue of the comparative rate of return and the degree of risk for an outside investment relative to mortgage acceleration.

• Comparative Risks

  From the lender’s standpoint, the risk for him is very minimal, since his mortgage is secured by your home and if you were to fail to meet your mortgage obligations to him, he can simply “foreclose” (recover) the property. For the real property salesperson, he incurs virtually no risk: he gets paid his commission up front at the time the investment in the property is made.

  For you, the homebuyer, though, the story is different. It is on you that the whole risks lie a 100%. Even if we were to accept as guaranteed that you can earn in an outside investment today a better yield than the compound rate you are paying on the mortgage, what is the certainty that you will be able to earn that yield every year, year after year for the 30 years or so your mortgage debt will last? Virtually none! You might be able to be ahead this year, or next. But what about five years hence? Or ten? Or fifteen? It is very doubtful that a string of such favorable yields will continue from any other type of investment over so long a period. The point is that, mortgage investment and accelerated payment of the mortgage are, on the other hand, the one investment that virtually assures such benefits! And mortgage investment is the one investment that has virtually no risk; a home is generally the safest investment available over the long term since money invested in your home has a greater chance of not being spent than money put in any other investments.

  In sum, the point is that you are much less likely to find any othe investment that will both yield a higher return and also have a safer risk factor than an investment in a home. The possibility, indeed the probability, is very real that even if you will earn on an outside investment something equal to or better than what you will get from accelerating on your mortgage, the value of your outside investment could fall, even significantly, over the course of the period. The reality, then, is that if you take the lender’s and the salesperson’s typical advise of taking out your “idle” home equity funds and “putting it to work” in other types of investment, you will be putting it to work, alright. But for the net benefit of the lender or the salesperson - and not yours.

• Illustration

  Lets see just how unlikely it is that you will readily be able to find an investment option that will both yield a higher return and provide a safer risk element than a home investment. Assume a mortgage of $80,000 at 10% interest rate running for a 30-year term, which makes the required payment $702.06 per month for 360 payments.

  First, on the yield issue, this would mean that, in order to match such a yield, the outside investment you pick would have to yield you 10%, compounded monthly, and continue to pay you that yield uninterrupted, year after year for the next 30 years. To see just how much more superior the yield on investment in home mortgage could get relative to the yield from any other investment, lets say that all you do is make a single, one-time-only pre-payment of only $100 towards the mortgage principal in the first month of the 30-year mortgage term. You will immediately find that the value from that $100 alone is substantial - some $1984. That one time $100 investment alone is worth so much - as much as taking approximately 3 months off the total term of the loan! Now, if your one-time-only prepayment were to be $1000, instead of $100, that will be worth (the yield to you) a whopping return of $19,837, and that alone will chop off more than 4 years (28.3 months, exactly) from the total term of the loan! And, because of the peculiar nature of the structure of loan amortization, the longer the loan term still remaining on the mortgage (or the larger the rate of interest and/or the balance on the loan), the higher the yield that will accrue to you.

  Now, the central question is: how does such a yield from investing in home mortgage compare against any other type of investment? For a given alternative investment to match these home-purchase investment yields, that investment in the same amount ($100), must be able to yield 10% return, compounded monthly, for no less than the same 30-year term. That is, if you invest $100 or $1000 today in a stock purchase (assuming that is the investment you choose), it must yield you a return of $1984 or $19,837, respectively, 30 years from today. In realistic terms, you are plainly unlikely to find such an alternative investment. And, even if you were at all to find one that could, in theory, yield you such a return on a straight line mechanical formula as of today, it will still be unlikely that such investment would be as safe as investing in your home (that the registered high yield of today will continue to be matched for as long as your mortgage term), or that the registered yield of today will still be available (that you would not have spent it) within the next 30-year period - something you would not have to worry about for an investment made in your home.

Myth#6 Debt (Mortgage) acceleration is only good during times when the home’s value is rising, but not when it is falling

It is a common argument held among many financial professionals and uninformed homeowners alike who are opposed to acceleration, that while mortgage acceleration may be justifiable and proper when the assumption is that a home’s value will rise over time, an acceleration plan is unwise when there is a depressed market and the home’s value is falling. The argument goes this way, as captured by one analyst: “Paying off your mortgage more rapidly is a smart idea as long as your home’s market value is rising. But if your home’s value is falling, you are throwing good money after bad.”

However, it is not so. In reality, quite to the contrary, this line of reasoning is badly flawed in a few ways. Fundamentally, the flaw in this argument lies in the fact that it assumes the mindset of an investor, not that of a homeowner - that is, it fails to make a distinction between your home as a unique type of long-term investment, and your other investments, a distinction that should be made based not on the paper profits made or potentially to be made (as in the case of other investments, such as stocks or bonds), but on the purpose behind the investment (as in the case of home investment). True, if you make a poor investment in, say, a mutual fund, it may be unwise to continue putting more money into the same fund in a falling stock market. But that will be because, generally when you invest in shares of mutual fund (or similar investments, such as stocks, or the futures), you often do so solely in the hopes of turning a relatively fast profit. And, the moment the profit comes, you take it and then put your money into something else. Not so, though, with real estate investment. With your own home, first of all, the overwhelming part of the appraised value of the object of your investment, the home, is represented by debt, and it may not be that easy for you to simply walk away from a home that has fallen in value when you probably still owe a substantial mortgage debt on it to your lenders. Secondly, with your own home, you are buying a personal asset, personal security, and safety - not a part of a portfolio. You and your family live in the home; you and your family have a place to live. The real, if intangible value and importance of this benefit alone, in and of itself, is immense. In deed, so immense, many home investment and financial analysts contend, that it surpasses the financial value of the home, and of the investment in the home. For, if the homeowner were simply to accept the reality of a depressed market and depreciated value of his home and walk away from the home, what does he and the family do about where to live, or about the money that will be necessary in order to pay for an alternative housing? Furthermore, he and the family will have to face the many other issues that often come with moving: change of job, finding new social contacts, disruption of the continuity of his life and those of his family, finding a new school for the children, etc.

The point, simply, is that because of the unique “personal security” value of owning a home to you, it is not readily practicable for the average homeowner to simply walk away from a house merely because of its falling value, in the same way that he might with respect to other types of investments or assets. And, the the same token, the notion that a homeowner should tie the value of a mortgage acceleration plan to whether the home’s value is rising or falling over time, is not the way things work with real estate investment. Rather, with real estate, you will have to view it as a long-term investment. Given your continuing need for shelter, your home is more than simply an “investment” and the value goes beyond merely its current market value. What all these mean, is that you are all too likely to set your mind on continuing to pay your mortgage debt until it is paid off, regardless of what happens to the home’s immediate value. And hence, since it is to be assumed that you will probably keep your home for many years even in depressed market, acceleration of your mortgage would still be a sound idea, whether the home’s market value rises or falls, for it is the amount you pay in interest overtime that ultimately determines the true value of your home, and not the momentary rise and fall in its market value.

Finally, look at this argument (i.e., that mortgage acceleration is only good in times of rising home values) this way. Recall the fundamental function and purpose of acceleration of mortgage repayment? It is essentially to reduce your interest expense. And, through that, the total cost of your home, and to build your equity more rapidly in the process. The point is that given that, that same acceleration will continue to save you that same interest expense so long as you are an owner of the property, regardless of the home’s value. To put it another way, since acceleration reduces the long-term cost of one’s mortgage loan (one’s home), it will still make sound financial sense even when the home’s market value were to be falling.

Example:

Lets say you purchase a home today valued at $120,000 on a 30-year, $100,000 mortgage at 10% interest rate. The $120,000 home will cost you a total of $335,925 over the 30-year life of the mortgage. (The $120,000 purchase price plus $215,925 in interest cost on the $100,000 mortgage). You can reduce that cost, however, to $215,925 by acceleration, by repaying the mortgage over, say 19.3 years. You will save yourself about $90,515. You will achieve the same result, by the way, by adding $100 every month to your regular monthly payment of $866.57 to make it $966.57. Now, if that $120,000 home were to double in value, or stay the same, or falls, it wouldn’t make any difference: you still would have had the $215,925 interest expense burden to carry on that property for so long as you own it and haven’t yet paid off the mortgage. Hence, in that way and during that time, acceleration of the payments will still continue to save you what it will save you, regardless of the home’s value.

Some potential vested interests of the mortgage lenders and real estate salespeople in propagating the myths

What are, at least, some of the possible underlying purposes and motivations for many who champion the above-stated myths and flawed arguments?

Michael C Thomsett, a noted real estate finance expert and author, advances one thesis. While observing that it is the bankers, the mortgage lenders, real estate salespeople, and sellers of investment securities, who generally make the strongest arguments against mortgage repayment acceleration and mortgage pay down, Thomsett adds that “to evaluate an argument, you must always consider the source.” Thomsett makes the cogent point that because such persons who argue against mortgage acceleration are often professionals with a vested financial interest who derive their means of livelihood primarily through the generation of commissions or interest from long-term borrowings and investments, such arguments must necessarily be viewed with grave suspicion.

Thomsett sums up in this way, why, in his assessment, it is no surprise that these professionals necessarily take the position they have taken against mortgage acceleration.

Lenders benefit when you borrow money or when you pay off a loan over the longest possible period. The more acceleration you achieve, the lower the lender’s total income. Lenders are in the money business, meaning they have to [to make] loans [to borrowers]. The longer the repayments period, the higher the use of that [loan].

Salespeople are interested in getting you to borrow the money with equity as collateral, because that means more commission income for them. There is no commission paid on acceleration, so salespeople cannot be expected to objectively compare advantages between investments on which they earn money [long-term loans], and strategies on which they receive nothing [by acceleration of payment].

The problem stems primarily from what Thomsett aptly calls the salesperson’s “dilemma”. The dilemma runs this way. On the one hand, the real estate and mortgage salesperson knows quite well that your investing your money in building up home equity as quickly as possible (i.e., in accelerated repayment of the mortgage) is the more prudent path for you, but on the other hand, he is keenly aware that given the limited cash at your disposal, any extra payments you are to put towards accelerated home payments would directly mean less monies that you won’t put into investing in his own business which would yield him commission - the stock market, mutual funds, public syndications, or annuities. As Thomsett puts it, the salesperson reasons this way: that “if you put in only $2000 [in investing in things like stocks, bonds and those types of investments he controls, so that you can invest more in accelerating your mortgage payment], the total commission for him is only $160. But if you invest $20,000 [in his type of investments by investing less in acceleration of your mortgage], the commission to him jumps to $1600.”

Consequently, Thomsett explains, the salespersons do the only thing that straightforward business logic and common sense would dictate that they do: they “appeal to your sense of guilt about how and why you should borrow to the maximum level possible and why you must put your home equity to work… [and how you are] better off paying your mortgage over the full term and investing your ‘disposable income’ somewhere else.”

At the heart of all these, is another fundamental factor, namely, a common mistake often made by the general public. The common misconception and general assumption on the public’s part is that investment salespeople (financial planners, advisors, consultants, and the like) necessarily have some special knowledge and expertise that the ordinary person does not have, or that such persons are unaffected by ordinary human bias or self-interest and are almost always objective in their professional advice and in the recommendations they make to clients. In reality, however, such an assumption is not necessarily valid. Indeed, quite the contrary is true. Anyone, for instance, can call himself or herself a financial planner as it requires no particular or specialized knowledge to qualify, and even those having genuine expertise in financial planning invariably acquire such expertise through a background in varied, different disciplines - in life insurance, mutual fund saled, the stock market, and the like. And chances generally are that they don’t understand real estate or the real cost of buying a house fromt the standpoint of the interest costs.

In sum, the point is that any investment advice or general opinions offered by traditional financial planners and investment salespeople on mortgage payment acceleration plans and strategies, should generally be viewed with a critical eye, anyway, and should at least be taken with a grain of salt.

Some different types of pre-payment plans available. Choosing an appropriate one for you.

The basic essentials of a workable pre-payment plan

We made the point that though mortgage acceleration (mortgage prepayment) should ideally be implemented as quickly as possible as it will more drastically reduce the overall cost of the home purchase that much sooner, the most important consideration and constraint in determining how, when, or even whether to commense a specific type of prepayment program, and in what amounts, is, ultimately, what your budge can bear. There are, of course, different types of prepayment plans you can choose from. The central point to be made about this, however, is simply this: whatever type of prepayment plan or program you adopt, if it is to be successful and workable in the end, it must be realistic, practical, and financially affordable to you in terms of your own budget. A realistic mortgage acceleration (prepayment) plan must also be and remain flexible, able to adapt and operate within the context of the ever-shifting limitations of your financial resources and personal budget.

Lets look at some five different types of acceleration plans or methods by which you can speed up the repayment of your mortgage debt, and offer some explanations of their respective advantages. Each plan works in essentially similar fashion and brings about dramatic savings to the homeowner. On your own part as a homeowner, you are free to choose any one of the plans, or even a combination of several plans - within the context of what is most suited to your budget and personal financial goals, what your priorities are, and your current financial status. The plan (or plans) you choose must, however, be practical (given the particular limitations of income and the other expense you have to meet). It is also very important that the plan you choose be one that you will be able to stick to and systematize, and that it be one that you will be able to work into your weekly or monthly routine. For example, choosing a prepayment plan that has a specific amount, and paying that amount each month - as in a Fixed Term PrePayment Plan, for exmaple - could be deemed an attractive plan by a particular homeowner because of its extreme simplicity and because it makes for a consistent plan. With such a plan, you are less likely to miss the extra money you pay, for example, as the payments will readily become an integral part of your budget.

The five different types of prepayment plans we will consider

The five types of prepayment plans we will discuss here are the following:

1. Flat of Fixed-Sum Prepayment plan
2. Principal-only (variable-sum) prepayment method
3. Fixed Term Prepayment Plan or Method
4. Acceleration with an Annual Lump-sum
5. Bi-weekly Payment Plan

Flat of Fixed-Sum Prepayment plan

In this type of plan, you pay your mortgage lender a fixed, flat amount each month, in addition to your required monthly payment. For example, say you have a 30-year, $100,000 mortgage at 10% interest rate, meaning that your normal monthly payment (the principal and interest only, and not including taxes and insurance) is $877.57. You will simply determine to add in each month an amount you can affort, say $100, to this payment, making the total actual payment $977.57 each month. Even this mere payment of this extra $100 per month alone would save you more than $90,000 in interest costs over the 30-year life of the mortgage, and would let you pay off the loan a little over 10 years sooner. The sole criterion for picking which amount you may prepay should be what you feel you can afford to pay extra without overstretching your budget.

• Advantages of the flat-sum method

  The flat-sum prepayment method has several attractive features and advantages. For one thing, this type of plan has the advantage of the element of certainty and predictability; the homeowner involved knows, in advance of each month, exactly how much more money he or she will have to be paying, and even more importantly, how much more he can afford to be paying based on his budget. Hence, all you have to do is, first, determine the amount of additional payment you can realistically afford without stretching yourself and your budget unduly - is it $50, $100, or whatever it is - then build that amount into your regular monthly budget. You continue paying this extra amount month after month until the mortgage is paid off. This additional amount is a fairly small amount that would hardly pose any hardship on the average homeowner. Yet, by adding just such meager sum meager sum to your regular monthly mortgage payment, the effects could still be phenomenal in terms of the interest saving you will make on your mortgage.

  In every type of investment whatsoever, whether it be putting money in a savings account or in making a mortgage payment, making sure to systematically put aside a specific, definite amount each month is often critical if one is to achieve one’s goals, since by and large, people do not readily follow through on the plans they make for reaching a goal. Hence, as a practical matter, consistently adding a constant, fixed-sum each month is a critical element which makes for the workability and successful implementation of the fixed-sum prepayment method of mortgage acceleration. Once the monthly figure is fixed, there is no further decidion to be made. You simply keep to the decision, month after month.

  A second advantage of the flat-sum method is somewhat psychological. The mere act of putting aside a fixed-sum each month has the psychological effect - and advantage - of constituting a habit. Since you do not have to make a decision each month regarding making the extra payment (you already know how much you are going to be paying each month), you may not feel the burden of parting with the money each month.

  Most people must necessarily adjust their lifestyle to suit their available income. So, when you are required to pay, say, $1000 on your mortgage, but you voluntarily take a decision out of your own personal sense of self-interest to pay $1200, you have psychologically created a specific level of monthly expense for yourself. Hence, as your income rises in the future, you do not feel or perceive the additional monthly payment necessarily as a burden because it is already built into your budget and because of the sense of mission you feel to attain a self-interested goal of debt-free ownership you have set for yourself. As one analyst put it, the prime advantage of the fixed-sum prepayment system is that is “has the inertial force built into it, it simply propels you toward your goal of debt-free ownership of home… it is as if your mortgage payments were fixed arbitrarily at a slightly higher level, and you were not told about it. It is a pleasant and profitable way of deceiving yourself.”

  Finally, fixed-sum prepayment method also has the advantage of simplicity. You simply determine how much more you can afford to prepay each month, and add that to your regular payments for each month.

Principal-only (Variable-sum) prepayment method

In a principal-only plan, you do not pay a set amount extra each month; rather, all you do it pay each month the next month’s principal amount due (in addition to your regular monthly payment), since, for each month, it will be the principal due on your payment for the next month that you will have to pay, the amount you prepay each month will vary. And because the prepayment amount you will pay each month will vary from month to month, this method is also called the “variable-sum” plan. In fact, this variable amount will gradually but surely increase each month as more and more of your monthly payment becomes applied to the principal.

Essentially, the cornerstone of the principal-only prepayment plan is the prepayment of an amount - comprised of the principal due on the next payment - as determined directly from the monthly mortgage amortization schedule.

To embark on this prepayment plan, first you would need to obtain a mortgage amortization schedule that specifically applies to your loan. What is it that you need an amortization schedule for? With this in hand, you will simply be able to determine, each month, the amount you need to prepay.

In a variable-sum prepayment plan, you can start your prepayment program at any time during the term of the loan, but whenever it is that you choose to start, what you do is this: simply add the principal payment of the next month to the regular payment of the present month. Notice what happens with the extra sets of payments. By paying the the principal due for the second month in the first month’s payment, you have saved yourself a lot of money on interest cost associated with the second payment. You will never have to pay that now. And by making the second extra payment in the second month, you have saved yourself an interest charges associated with the third month’s payment. But that is not all the savings you have made yourself by this. In addition, by merely making those two extra payments of the principal alone, you have also chopped two months off the life of the loan - you will own your home debt-free that much sooner. Indeed, if you were to keep it up and dutifully send in one such extra prepayment check each month with each regular monthly payment, you will cut the life of the mortgage in half by that alone, paying off your mortgage in 15 instead of 30 years.

What if there are some months in which you find yourself unable to make the extra payments? Then, you simply don’t prepay for those months. You can simply make your regular mortgage payment for that month (or those months); and whenever you happen to come by some extra cash for particular months in the future, you could make a prepayment of your mortgage principal to further save yourself tremendous interest costs.

Note: As a rule, to achieve the maximum savings you would need to do so by starting the prepayment plan as soon as possible since it is during the earlier stages of the loan term that the larger portionof your payments are applied towards the interest charges, rather than to the principal. During the earlier stages of the loan term, a far larger portion of your monthly payment goes to the interest charges, and it is only towards the latter part of the loan term that a large portion of the monthly payment goes towards reducing the principal (the actual loan amount).

• Tracking your prepayments in a variable sum prepayment method

  Since the amount of the principal you prepay each month will vary under this type of prepayment plan, one important question for you may be how do you keep track of the prepayments you make and, more particularly, the savings you make, for each prepayment? And how do you keep track of the progress you are making towards that much-desired goal of paying off your mortgage much sooner?

  First, right off the bat, one very helpful thing you can do is, don’t ever wait until near the end of your mortgage term to make sure you have gotten credit for the extra payments you make. Make it a habit. Once a year, be sure to request a statement from your lender showing how much in principal and interest you paid during the year, and the balance still remaining on the mortgage. Always check the statement carefully to be sure that it accurately reflects the prepayments you did make.

  Beside this, here is what you can do on your own. From the same amortization table you use to determine the amount you are to prepay for each relevant month, you can prepare a special amortization table worksheet which contains columns to enter the “prepayments” and “interest saved”. On the worksheet, you enter the payment numbers, the principal, the interest, and the ending (unpaid) balance amounts. If your prepayment program is started later down the road sometimes after the start of the mortgage payment and you have fewer remaining payments left on your mortgage at that time, then your worksheet should only show the remaining payments, broken down between the principal, interest, and unpaid balance.

• A drawback of the variable sum prepayment plan

  It is worth noting that there is one major drawback associated with the variable sum prepayment method, namely: a special feature of this plan is that as your payments on the mortgage progress, the prepayment amounts (i.e., the principal amounts) you are supposed to be making will no longer remain small, but gradually grow larger and larger with each payment, and will also not be saving you quite as much in interest as the earlier payments did. Indeed, your prepayments will become dramatically larger and larger from just about the time you pass the halfway point of your mortgage term, and at some point further down the way, you may find that the prepayments are now so big in size that having to come up with the prepayment amounts on top of the regular monthly payment is now darned well difficult. The reason you have this phenomenon of rapidly increasing size in the prepayment amounts (and the corresponding decrease in the savings you make on each prepayment), is because, given the way the amortization table is structured, it is at that later period in the amortization schedule that a greater portion of your payments goes towards paying off the principal, while a proportionately smaller portion goes towards paying the interest.

  Consequently, one realistic drawback of the variable sum prepayment plan you should be prepared to confront is that, in the later years further down the amortization road, your prepayments would far outgrow its earlier “spare change” status and become quite steep; prepayments will, as one analyst sums it up, “no longer be fun; it turns into a daunting task.” Indeed, at that point in later years, adhering to such a mortgage plan may mean almost double the original payment! What do you do at such a stage? One option that is certainly open to you, is that you may always cutback on your prepayment then. There is, after all, no obligation under the terms of your mortgage that you must make any extra payments other than your regular payments. Hence, if at some point during your prepayment program under this plan, you find yourself no longer in a position to prepay, that is just fine. You can stop for a certain period of time, or for any month, and prepay in any month you find yourself with some extra cash to spare. The choice is entirely yours.

Fixed-term prepayment plan or method

With this plan, what you do is to determine the mortgage pay-off date you desire - the length of time you would want by which to repay or pay off your mortgage - and then calculate the amount you would need to be paying each month in order to reach that goal.

Ideally, the prepayment amount you go with should be something you can reasonably afford over the duration of the pay-off period chosen. However, under this plan, even if right now you cannot readily afford the payment that is required to meet that goal, you may simply pay what you can at the moment. Factored into this, is a fairly reasonable assumption that financial conditions will change favorably (or at least ot get worse) for you in the future, and that you might well reach your goal by adjusting your payment (upwards) again and again in the future, as warranted, to make the goal.

The loan must be a conventional, fixed-rate mortgage for a fixed term prepayment method to be feasible. With adjustable rate mortgages, fixed term prepayments are simply not practicable as you will have to change your payments every time there is an adjustment in the interest rate.

Lets say that what you would rather do is cut down the life of the mortgage and pay in all off in, say, 25 years, or 20 years or 15 years, rather than 30 years. How do you determine the prepayment amount you will require (or the savings you stand to make) for the goal you choose? Look up the figures from the amortization table. Look for the “Monthly Payment Necessary to amortize a loan” type of table.

An important advantage of the fixed term prepayment system, is its sheer simplicity. You simply determine the length of time by which you want to pay off your mortgage and own your home free and clear, and your monthly payments are fixed based on that term. You would be able to speed up your mortgage prepayment and own your home debt-free some five, ten, fifteen, or so years sooner.

Acceleration with an annual lump-sum payment

Another type of prepayment method is to make a regular prepayment of lump-sum amounts. Many homeowners, already strained from month to month on other family expenses, lack the resources to allow for any flexibility, and some may find, even after a lot of disciplined budgeting and careful planning, that adding an extra payment on top of the existing family budget, is just too much of a burden to bear, at least immediately.

Given that situation, one viable alternative might be to use your annual income tax refund to accelerate the mortgage. Merely adding a $1000 refund amount annually to your mortgage will reduce your repayment term my 224 months or 18 years and 8 months; and adding just a $300 refund annually to your mortgage is equivalent to making extra $25 payment per month towards your mortgage, and will take as much as 5 years off your repayment term. And so on and so forth, with different amounts.

For this plan to really work and yield you the usual substantial benefits of serious mortgage prepayment, such lump-sum payments must be constant and regularly made, attended with dedication and a sense of purpose till the mortgage is finally paid off.

The biweekly payment method

Simply put, the term “biweekly” means every two weeks. There are 52 weeks in every year. Hence, a biweekly payment plan implies a plan whereby you make your payments biweekly, rather than every month, or twice a month, and the like. In this method, a borrower typically makes 26 payments in each year, as opposed to the merely usual 12 payments. This basically means that you take the annual mortgage amount you pay and simply divide it up in such a way that it comes out to your writing a check every two weeks, rather than once per month, or even twice per month.

There are a few ways you can accomplish this. For example, you can take your usual monthly mortgage payment amount and split it into half, then take that half-month rate and pay that every two weeks - rather than making one full month’s payment every month. Or, another way of mechanically doing the same thing is this: since there are 26 two-week periods in a year, you simply divide your regular annual mortgage amount by 26 and that is what you pay each and every two weeks until your mortgage is fully liquidated.

Here is the really significant point about this method. When you pay once every two weeks, that amounts to making 26 half payments per year, and when you make 26 half payments for the year, that is 13 full payments (13 full month’s worth) for the year. To put it another way, what this basically means, is that because there are 52 weeks in the year, the mere fact that you pay biweekly, instead of every month, directly translates into your making 26 half payments per year, which means 13 full months payments for the year. That is, instead of payments amounting to just 12 full months of mortgage payments for the year, you would have made payments which amount to 13 full months worth! That is equal to one additional month’s payment per year. That one extra month’s payment you make each year is applied toward your loan’s principal, thereby reducing the repayment term and saving you tremendous interest charges over the term of the loan.

Whether you are paid once every two weeks or monthly, you can try to budget your paycheck and schedule it so that you pay one-half of the regular monthly mortgage every other week. For each year, you would wind up prepaying one extra month’s regular mortgage payment and that extra payment each year gets applied toward the mortgage principal.

This one extra payment alone would result in a tremendous reduced interest costs to you as a borrower, and speedier payoff of the mortgage. How tremendous and how much speedier? For example, that will reduce a 30-year loan to between 18 and 20 years for repayment - just that alone is sufficient to cut the time of your repayment by 10 to 12 years, or more than one-third of the whole term.

What if I plan to live in my home less than 30 years?

Why would you bother trying to pay off your mortgage early if you are probably going to sell your house and move?

The answer is automated forced savings. The faster you pay down your mortgage, the faster you build equity in your home. When you sell your home, you cash out that equity. At that point, you can either use it to help you buy a new home with a smaller mortgage or use it to increase your savings. Either is great.