It seems appropriate that I’ve reserved Thursdays to discuss the Money Merge Account and Thanksgiving is celebrated on Thursday. I know, I’m a bit predictable. Here it comes. MMA is a turkey. Happy Turkey Day.
I believe the Turkey is saying “the factorial math will save you a bundle, you can’t do this one your own!”.
Joe
When I was discussing Mortgage interest, I received a few emails asking to to spell out a bit more clearly how regular mortgages calculate interest vs how home equity lines of credit (HELOCs) calculate. Fair enough.
One disclaimer; before you act on my explanation here, confirm with your bank that your mortgage is as I describe. I share here my understanding and experience, but it’s certainly possible that your bank follows different rules.
A standard fixed mortgage with a due date of the first of each month will often have a grace period allowing payments up to the 10th or even the 15th of the month with no late fee and no extra interest accrued to the account. On a monthly payment of $1200, this extra 15 days float is worth about $36 assuming a 6% mortgage. You see, it’s money available 15 days per month or half the time, so half of $72 is $36. Not a huge sum, but if your bank has a grace period this generous, you can save a bit by taking advantage. Just as the bank may have a grace period, they will not offer you any savings by paying a week, two weeks, or even a full month early unless you specifically note the extra funds are to go to principal. In that case the next regular payment is still due on the upcoming first of the month.
A HELOC, on the other hand, charges interest to your account based on average daily balance. I know of no bank that will lend you money from the 1st to the 29th but if your balance is $0 on the 30th will charge you no interest. That suggestion is absurd, and repeated by people who are either very confused, or those trying to perpetuate a lie. Just because someone in the mortgage business believes he “borrowed the bank’s money interest free” doesn’t make it so. In fact, it undermines his credibility as well as the agent who uses such nonsense as “proof” and a testimonial. To be clear, whatever the rate is on your HELOC is multiplied by your balance at each day’s end and accumulated over the course of the month. If you borrow money on the 1st and pay it in full on the 3rd, that’s 2 days interest. If you run a small balance, this may just amount to pennies, but you are still being charged this interest each day.
MMA agents will confuse you with this even more easily than they confused this mortgage broker. They will suggest that there’s some magic to the the way HELOCs calculate interest vs how the standard mortgage calculates. There may very well be a few dollars savings to be captured, but that’s nothing compared to the $1000 you are prompted to pay each month from your own money. Don’t be confused into believing the software creates this savings. In fact, when you ask an agent to run an analysis using as little discretionary income as possible, you’ll find they offer you numbers that easily show the lack of value of this software. I’ll discuss their analysis further in a couple weeks.
Joe
If you have not yet done so, please read part 1, part 2, part 3, part 4, part 5, part 6, part 7, part 8, and part 9 of this series first, then read on.
I received a number of emails after part 5 where I mentioned the HELOC use, but didn’t explain what MMAs claims are regarding this process. So let’s review the claims of the MMA agents.
While an honest agent will acknowledge that the prepayment of principal mostly comes from the paychecks of the home owner, many have managed to exaggerate the saving due to HELOC use and suggest that one can’t do this on their own. In the classic example, the client has $5000 worth of income, and $4000 in expenses. You’d imagine that during the course of an average month the client will see that their (0%) average monthly balance is as much as $3000, even though they may end the month with little sitting in checking. So what MMA claims to do is to borrow the difference ($2000) from the HELOC, depositing $5000 toward mortgage principal, and borrowing back from the HELOC as expenses arise. In theory, if the HELOC rate were the same at the interest rate on one’s mortgage, this strategy would create a rate of return on that average $3000 equal to the rate on the mortgage. But as I reviewed in my part 5 in this series, even if we assume the entire month’s income is available the whole month, the best we’d see from the HELOC use is $5000 x 6%, or about $300 per year. If we fall back to the $3000 average balance, the savings is just $180/yr. Not bad, right? But when we take the cost of MMA ($3500) and pay it off over the 10.4 year example, we find the annual expense to be $453/yr. For MMA to just break even would require an average checking balance (which for some odd reason is earning 0%) of $7,550. This would imply a monthly net income closer to $10,000 at a minimum. Nowhere else are these numbers discussed or disclosed. The latest version of MMA (V4) does take the claims to a higher level. The new software assumes another month’s float from the client using a credit card to charge every expense for the month, and use that float to pay toward the mortgage. Don’t fall for that either.
The agents promoting MMA manage to combine their own lack of understanding with a series of outrageous claims and take advantage of the average Joe not understanding how compound interest works. So far, in this series I have shown you the maximum amount you can possibly ring out of your ‘idle’ cash, and have shown how it’s a tiny fraction (a thousand dollars, if that much, vs the $164,000 in interest one can save) of the savings simply created by prepaying your mortgage with that same $1000/mo free cash flow.
Joe
If you have not yet done so, please read part 1, part 2, part 3, part 4, part 5, part 6, part 7, and part 8 of this series first, then read on.
Last week, we started to discuss how mortgages work, showing the effect of paying a small extra principal payment along with your mortgage. Now, I’d like to offer at a glance, the require payments for a $200K, 6% fixed rate mortgage for different lengths of time:
We can see above that a small increase in monthly payments, $89, will drop the payoff from 30 years down to 25. Another $144, and it would drop down to 20 years. Again, this is simple math, not rocket science. MMA examples suggest that an additional $1000 per month and MMA will have you pay your mortgage off in 10.4 years. Look above, a 10 year mortgage has a payment $1020 higher than the 30 year mortgage. If you wish to pay your mortgage off in this amount of time, regular prepayments will achieve the same results as any expensive software.
It’s important to note that shorter term mortgages always offer a lower rate that the longer term. Typically, a 15 year will be 1/2% lower than a 30 year mortgage. What does that mean to you? It suggests that if you are aggressively paying ahead you will find that when you show you are at the 12-13 year mark (i.e. about 17-18 years left) you may be able to refinance to a 15 year loan and see only a slight increase in required payments.
More important, this implies that if you have the ability to throw all this money at the mortgage, why not consider the shorter term in the first place? This is something the agents never seem to discuss, perhaps because they don’t understand how mortgages work.
Next, let me offer another snippet of spreadsheet, this one similar to last week’s but with some additional details:
What I added above were two additional columns, one to show remaining months until the mortgage is paid off, and next, the amount of interest that you will not pay due to prepayments. You can see, the first extra payment of $1000 reduces your mortgage by an extra 5 months, so after that first payment you have only 354 payments left (plus a bit). After those first two prepayments, you are now a year into your loan, with just 29 years to go. This is from a larger spreadsheet I offer my readers, one in which you can enter your mortgage amount and interest rate. You can then track your own progress on your loan and see what impact any prepayments would have on your payoff time.
Note: The spreadsheet I referenced is available upon request only. At this point, I still prefer to track how many times I’ve sent it out, and follow up with the people who have requested it, asking for comments and questions. Please add a comment if you wish to receive a copy.
Next week, more on the HELOC shuffle.
Joe
If you have not yet done so, please read part 1, part 2, part 3, part 4, part 5, part 6, and part 7 of this series first, then read on.
I think we are at the point in this series where I should take a step back and offer a simple overview of how mortgages work. First, to show you how simple this topic is, I will offer you the “Rule of 72″. If you divide an interest rate (6% in most MMA examples) into the number 72, you get the number of years it takes money to double. 6 into 72 is 12. So at 6%, it would take money 12 years to double. Now, let’s look at the first lines of an amortization table for a $200K 30yr fixed mortgage at 6%;
| Balance | ||||
| Month | Payment | Principal | Interest | 200000.00 |
| 1 | 1199.10 | 199.10 | 1000.00 | 199800.90 |
| 2 | 1199.10 | 200.10 | 999.00 | 199600.80 |
| 3 | 1199.10 | 201.10 | 998.00 | 199399.71 |
| 4 | 1199.10 | 202.10 | 997.00 | 199197.60 |
| 5 | 1199.10 | 203.11 | 995.99 | 198994.49 |
Here, we see that the monthly payment is $1199. What would we save at the end if we sent $100 more to the mortgage? Well, 24 years is twice the 12 it takes to double, so at 6%, in 24 years we’d have $400, another 6 years, and it should be worth close to $600, right? Well, back to the amortization schedule and we see that if we pay an extra $200.10 along with the mortgage payment due for month 1, we actually get a full month ahead on our schedule. Agents selling MMA use the word ‘canceled’ for this process, saying that “MMA canceled $999 in interest in just one month.” And in a case that lies north of innumeracy, and south of hyperbole, they suggest that you got a 500% return on your money, instantly. You can see how on one hand, the math is pretty easy, you can get very close without even using a calculator, yet on the flip side, one who doesn’t understand the numbers can be convinced of something not true. $200 today is the present value of $1200 30 years hence at 6%/yr. So, you can look at this 2 ways, the extra $200 payment pays the payment #360 in advance, as it knocks off the last payment due, or looking at above, you’ve just paid payment #2, and next month, you are on line 3 of the table. The amount you prepay against principal doesn’t need to be any particular amount. If you have $100/mo extra, over one year’s time you will have paid your mortgage ahead by about 6 months. To be clear on this last thought, using a spreadsheet on your computer will give you exact numbers, but even a printed spreadsheet you track with a pencil is all most people actually need to get the job done.
Next week, we will continue and conclude our discussion of mortgage math.
Joe
If you have not yet done so, please read part 1, part 2, part 3, part 4, part 5, and part 6 of this series first, then read on.
Whose money is it? By that I mean if you take $1000 and the MMA software tells you you just ‘canceled’ $4934 in interest off the back end of the mortgage, representing 5 months worth of payments, do you pat yourself on the back for prepaying your mortgage, or do you let someone convince you the savings was from ’sophisticated algorithms’? Let me offer you an example from The Jubilee Project, this is from a letter a satisfied client wrote;
We invested in the Money Merge Account May of 2007 without completely understanding how our 30 year fixed mortgage and other debts were going to be paid in full in less than 7 years.
Well, without getting too pedantic, this is simply not an investment, but that’s a tangent I’ll skip. One should never go down a path such as this without a complete understanding of what they are getting for their money. The claim that this guy’s mortgage would be reduced to 1/4 of its duration should have him curious as heck how exactly this will happen.
We began the month of June with a zero balance on our HELOC. Following the cues of our Money Merge Account we chose to withdraw $ 28,538.81 of the banks money from our HELOC and send it to our 1st mortgage as a principle reduction. We then deposited $ 20,687.17 that had been sitting for 15+ years in a low interest bearing savings account. You will see that our ending balance was $ 7,851.64 at an interest expense of $ 7.79. That interest expense of $ 7.79 was calculated off of our Average Daily Balance of
$ 1,266.39. For the month of June we had the use of $ 6,585.25 of the banks money interest free! We found that “A - B = free money” formula to be both counterintuitive and bazaar (sic)! Essentially, we leveraged the banks money through the HELOC resulting in what could be called a To-Good-To-Be-True interest savings for us on BOTH our 1st and 2nd mortgages. This simple math edified for us how we will be mortgage/debt free in less than 7 years!
1. HELOC: $ 6,585.25 (leverage & float the banks money with no interest charged)
2. 1st Mortgage: $ 74,073.23 (canceled interest = 10 years of canceled mortgage payments)
3. Total Interest Saved: $ 6,585.25 + $ 74,073.23 = $ 80,658.48
Now, you can also view that client’s HELOC statement, and you’ll see two things. First, he draws a HELOC advance but takes his cash savings and pays it back the same day. Not really an issue, but $20,687 came from that client, and $7,851 from the HELOC. Second, he seems to be so fascinated by the minor interest charge for this shuffle, but it’s nothing remarkable at all. The money is drawn on 5/29 and a statement is cut on 6/2. It’s 4 days interest, not rocket science. And this client works for a mortgage company? To take this to an absurd extreme, if one borrows $50,000 off their HELOC just before the statement is cut, they may very well see no interest charge at all as none has accrued. But to suggest that it was borrowed at ‘no interest’ is simply wrong, and again, will be clear after a full month has passed. If he (and his wife) are comfortable to deplete their savings, preferring instead to use those funds to reduce their mortgage term, that’s fine by me. He may have other assets to tap, or is comfortable relying on his HELOC if he has a short term need for funds. But don’t let the smoke confuse you, he sent his savings to pay down his mortgage.
As far as his note (1) above is concerned, that $6585 is meaningless. He really owes $7851 on the HELOC and it’s accruing interest at 7.24%, so unless he pays it down from income, it will be $47.37 in interest for the (full) month. Not to be too unkind regarding this, the calculation of interest is an important thing to understand. Ending balance ($7851) and average balance ($1266) cannot be subtracted or added, the numbers simply reflect the number of days that loan was outstanding. The only time the client wasn’t charged interest was when he had no loan, prior to 5/29. He never borrowed money at zero interest. In (3) his statement that the difference of $6585 was saved interest is nonsense, it’s actually the average amount not borrowed though the month. Projecting out (3) that he just saved $74,073 due to the prepayment is something I won’t dispute, but that was a choice he (or any client) had the day before signing up for MMA. Next month when his furnace breaks down, or transmission goes, or any other unexpected expense rears its head, he will have no savings to draw on, but he will have to tap his HELOC further at the 7.24% rate. I don’t imagine the agents selling this software are too eager to discuss this twist.
I also note that since this client is in the business, one would think he’d be refinancing his mortgage to a lower rate, not using a higher interest (which should have dropped over the last year) HELOC to float that debt. The owners of Jubilee find this client’s letter to be proof of MMA success? I think this proves nothing, except how easily people are confused, and even the so-called experts do not understand how mortgages work.
The client goes on to offer:
The interest canceled for our $ 3,500.00 investment in the Money Merge Account for the month of June ‘07 was $ 80,658.48.
Ok, let’s think on this. I don’t know what his mortgage balance was, or its rate. But I do know that his reference to the $6585 is misguided at best. He saved $74,073 but this just reflects the time value of money. Where does he account for the $3500 fee? Anyone can take their saving and throw it against the mortgage, can’t they? And what of the $7851 HELOC balance? It’s now costing him more interest than his mortgage was, as it has a higher rate. It’s really easy to look at a spreadsheet or calculator and see that at the beginning of a 30 yr mortgage, if you make a lump sum payment of say, $10,000, you just reduced your balance by $53,624. If it’s from your savings, you just got a return on those funds equal to your mortgage rate, nothing wrong with that. But if you borrowed it off your HELOC, at or above the rate you pay on your mortgage, you’ve accomplished nothing, and are worse off.
Next week, I take a step back and discuss the ‘rule of 72′ and how mortgages work.
Joe
