A New Way to Pay Off Your House

Here's a new, interesting idea. It's called an accelerator loan and it's designed to help you pay off your mortgage early. These loans have been popular in Australia and the U.K. (where one-third and one-fourth of homeowners use these loans respectively) and are now coming to the U.S. The overview from MSN:

Not to be confused with biweekly programs that shorten a mortgage through extra payments, the mortgage-accelerator program is based on an approach common in Australia and the United Kingdom, where borrowers deposit their paychecks into accounts that, every month, apply every unspent dime against the mortgage loan balances.

The piece then gives the details:

The premise is that borrowers finance a purchase or refinance existing property using home-equity lines of credit. Borrowers then directly deposit their entire paychecks into the credit accounts. Monthly expenses, other than mortgage payments, are funded by draws against the lines of credit, whether those are through automatic bill payments, checks, cash withdrawals or credit cards. Even if borrowers end up not paying anything extra on the principal during a month, they still capture some interest savings because the average balances are less than they would have been with conventional loans.

What? I need an example. Here goes:

As an example, let's say your mortgage payment on a conventional fixed-rate mortgage is $2,000 and your monthly net income is $5,000. With the mortgage accelerator, even if you spend the $3,000 difference, your average mortgage balance for the month is $1,500 less than it was with the conventional mortgage. That's because the entire $5,000 is deposited in the loan account and you made draws of $3,000 for living expenses spread over the month. At a 7.75% loan rate, that saves you about $10 in interest expense that month.

Now, $10 here and $10 there does add up over time, although both loan programs have annual fees of $30 to $60, but the accelerator part of the mortgage lies in having all your net pay going against the mortgage and an assumption that you have a positive monthly cash flow -- meaning you don't spend as much as you make.

In addition, these loans have an advantage over simply making additional payments on your mortgage:

Where a mortgage-accelerator loan program gives a homeowner additional flexibility, however, is in having a line of credit available if there is an emergency need for cash. If you make additional payments on a conventional 30-year fixed-rate loan, you can't borrow that money without taking out a home-equity line of credit or a home-equity loan. With the mortgage-accelerator program, you already have the line in place. That gives homeowners confidence that they can be aggressive in paying their mortgages and still have money readily available if a financial emergency crops up.

There are a few "watch -outs" (variable rate interest, etc.) that the piece also details, so if you're interested in more details, click the link above and read the entire article.

A few thoughts from me on this issue:

1. This is certainly a step in the right direction -- much better than the evil house loans we seem to see so much of.

2. In the end, this loan helps you pay off your house early, a financial move I support.

3. Personally, I don't like the "deposit your entire paycheck, use what you want, and the rest goes towards the mortgage" part of this. Seems like it would be a hassle if you wanted to keep a bit more in your account to save up for something down the road. (Maybe you'd then just transfer the money to a savings account?) I like a bit more freedom, and since I was able to be disciplined and make my own extra mortgage payments, I paid off my house the old-fashioned way. But, as the article says, accelerator loans will help people who aren't disciplined but who do want to pay off their mortgages early.

Comments

[Lazy Man and Money]

That is interesting. I'm having trouble figuring out in the example if that $3000 that I take out "to live on" is at an interest rate equivalent to a HELOC. If that's the case, I'm not sure I want to pay that 8+% of what I have today. That's especially true considering my fixed mortgage is at 5.875%.

Some (including me) would argue that it's best not to accellerate a 5.875% mortgage. However, you better believe I'd be trying to get out any 8+% interest mortgage.

I don't think I like this new way of doing things, but I support there being a choice for people.

[Mike]

Sounds like a great tool in the hands of someone responsible, and a bad tool in the hand of someone irresponsible. Just like a rewards credit card can be.

Someone irresponsible could turn this into an interest-only loan, or even worse a reverse loan.

[Frank Morana]

That's my idea of serious banking. The balance of your debt is calculable daily, and it is subject to the same daily fluctuation you would have in a traditional money account. But any funds you're not using in any given day will serve to reduce your debt (and interest charge) for that day. And if you need a withdrawal for any purpose, ordinary or extraordinary, you have a built-in line of credit, collateralized by your home equity. The problem is in the upwardly-adjustable rate, and on the extent of the percentage of equity vs. loan that you could withdraw.

[edenz]

I agree that I wouldn't like depositing my entire paycheck into such an account. However, my company allows you to set up direct deposit into multiple accounts. It is a very interesting idea.

[Angela]

These accounts are more commonly recommended in the UK for people with variable incomes (eg self-employed), to maximise the savings. If you then don't have a separate savings account, you can use this to store your emergency savings and you have an effective tax-free interest rate that is the same as your mortgage rate, say 5.5%.

I think you'd need to be very disciplined with this account, unless the massive debt number on the account scared you into paying it off more quickly.