A Better Way to Pay Off Your Mortgage Early

home_mortgageOver the years, a number of ways have been touted to pay off a mortgage early. Recently, we’ve seen a number of solicitations for a new way to do it.

The basic idea is to take out a Home Equity Line of Credit (HELOC) with your chosen bank. You use this account like your primary checking account. You will pay all of your bills out of this account and deposit all of your income into it. Any left over money goes to pay off your mortgage.

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The benefit is appealing – you may pay off your 30-year mortgage in as little as 10 years. Of course, if you have any other debt (e.g. credit card debt or car loan), it’s almost certain you should pay that off first.

We’re talking in generalities here; you and your financial planner can determine your best financial move based on your specific situation.

The pluses

We liked that the program we looked at included a great visual that showed you the exact month and year your mortgage would be paid off if you stuck with it. We also liked that you could easily see your money coming in and going out.

Using intuition

The example showed a rate of 6% on the first mortgage and an 8.6% rate on the HELOC. Intuitively, it didn’t make sense to us to borrow at 8.6% to pay down a 6% loan.

So we decided to do some calculations to see if our intuition was right.

New vs. old

We decided to compare this new way of paying down a mortgage to the oldest of the old ways – including an additional amount with each regularly-scheduled payment.

The example we looked at was for a couple who made $5,000 a month and had bills totaling $4,000 each month. They held a $200,000 mortgage, with a 30-year term, and an annual interest cost of 6%.

The main driver – with the old way or the new way – was the $1,000 in discretionary money each month. The new program also accessed the HELOC in the first or second month, but once again that money is being paid back at 8.6% instead of 6%.

Apples to oranges

We found that the new program lived up to its promise – you will pay less in interest over a 30-year period. The problem is that it’s an apples-to-oranges comparison.

Their basic assumption is that you will use ALL of the $1,000 in discretionary money each month to pay down your mortgage if you are on their program. If not, you won’t use ANY of it – that is, you won’t pay down your mortgage OR invest it.

Apples to apples

So we decided to do our own comparison. We used the simple, old, do-it-yourself extra mortgage payments method – we added the $1,000 of discretionary income to our monthly mortgage payment.

The result?

We paid off all of our debt (which consisted of only a first mortgage) eleven months faster than they paid off theirs (which included the first mortgage and the HELOC)!

We found some of the assumptions about the timing of income and expenses questionable. With a more conservative approach, we would actually pay off all of our debt fourteen months faster using our old-fashioned strategy.

As for total interest savings, we would save between $10,989 and $24,210, depending on the timing of income and expenses discussed in the previous paragraph. This takes into account the cost of their software as well as a small annual fee on the HELOC.

Conclusions

In a strictly financial sense, the old-fashioned way is your best bet. However, it’s important to also consider the human side.

That’s where programs like this come into play – some people would be more likely to pay off a mortgage early because they could track their progress so easily.

Of course, you could set up one account yourself. With basic spreadsheet skills, you could set up a chart (or talk a friend into doing it for you) to show the effect of additional mortgage payments.

The bottom line – the old way is the better way if you’re looking to save the most money. But if you’re a little light on financial discipline, programs like this may be helpful.

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2 replies
  1. Tim Noice (Renee Noice Husband)
    Tim Noice (Renee Noice Husband) says:

    Great point. The fees of a program, such as this, may out weigh the advantages. However, many people feel that their 401k or investments are making more than the 6%, which is the cost of the mortgage. Why would you utilize the extra $1,000 to pay the mortage down early if you could utilize the $1,000 in the 401k or investment account and stil have the tax deductability?

    Thanks,
    Tim-

    Reply
  2. George
    George says:

    Tim – I agree with you … if you can earn a return greater than the 6%, you’d be better off, financially, investing the money rather than paying off the mortgage. It’s also true that 6% would be a relatively low hurdle to overcome, especially in a 401k as you point out. Some people, however, just won’t feel financially secure until they have no debt. Thanks for adding to the discussion!

    Reply

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