Why would you want to accelerate the principal payments on your mortgage?
This week, we focus on managing your money to benefit you. In Bermuda's current economic environment, keeping up with the home mortgage payment is probably the number one challenge for every Bermuda homeowner.
The last several years of the Bermuda Monetary Authority Quarterly Banking Digests (2008 of 2.3 percent to 2013 of 12 percent of non-performing loans to total loans) indicated, too, a steady increase in the number of property owners struggling to meet those payment responsibilities.
So, why would anyone want to accelerate principal payments on a home mortgage or equity line? There are good reasons, the best being that the long-run savings stakes are enormous. Additionally, prepayment on the principal of your mortgage:
1. Scoops up surplus family cash that otherwise just “drifts” away on casual spending.
2. If you are less than ten years from retirement, can help you ensure that you are mortgage and worry free when that day arrives.
3. Saves a tremendous amount on the mortgage interest that goes to the bank each month, interest that you will never recoup (unless you are US connected and may be able to deduct a percentage of the interest expense on your US tax return, but that is another story).
4. Keeps you in control of your finances.
5. Best of all, you can accomplish this goal yourself without the cost of paying a planning consultant, buying very expensive financial incentivising software, or using programmes (by paying a financial salesperson) promoting accelerating mortgage paydown solutions.
True Story. In my 14 years of writing this column, I have often advocated paying down a mortgage a priority, and as quickly as possible — particularly if you are in your 50s. At one of my recent financial planning presentations, a dear lady approached afterwards. She very proudly announced that at the age of 63, even though she had recently lost her job, she had paid off their home mortgage. She was elated and we congratulated her. They own their home outright!
This is how this lady managed to hoard extra cash over the years, cash that was applied directly to the principal reduction of her mortgage. She opened a separate account — in her own name. Every single opportunity that came along, pay raises, bonuses, etc, she diverted small amounts into this account. No one knew there was extra money available when budget was short, so the family just tightened their belts.
Meanwhile, year after year, she knocked down the principal on their mortgage, on top of their regular mortgage payments. “You know,” she said, “sometimes I felt so guilty — holding out on the rest of the family — by not using the extra cash during those tough times! But now, we are so happy to have no debts, it was all worth it. And I have already found another part-time position.”
Her path of financial management may not be for everyone, but she was absolutely determined that the family would have a stress-free secure retirement and a place to call a home of their own — for real.
Not maths comfortable? This may seem a daunting task, but it works. Testimony is out there. You can do this yourself, for free.
Here is how you can use prepayment acceleration of your mortgage to meet your home ownership goal.
First, there are two things you must research in order to start your DYI (do it yourself) Accelerated Mortgage Calculator program.d
a) Review your original mortgage document contract. Yes, I know, the last thing you want to do after a long day at work is dig somewhere in all those official-looking papers. Look for the wording including a prepayment clause. Each mortgage contract is a little different, so while you may get together with friends to discuss this, remember each bank mortgage contract may not offer the same things.
b) Next, review carefully to see if the bank contract penalises you for trying pay off the principal of the mortgage early.
If there is no prepayment clause, you may be out of luck. Sorry for you.
Otherwise, generally, most lenders provide some sort of a prepayment allowance. It may be up to $50,000 in principal reductions a year, or a percentage of the mortgage balance, or they may assess a prepayment penalty that is not that demanding.
Let's review some illustrative facts to demonstrate the savings by using the Free Accelerated Mortgage Payoff Calculator at Bankrate.com
You can also go to the Get Rich Slowly Personal Finance that Makes Cents to work on mortgage prepayment made easy: Own your Home in Half the Time.
These are just a couple of the free mortgage software programs out there, free for the visiting and using.
We will use a mortgage of $400,000 for 20 years with a 6.5 percent mortgage interest rate — reflective of the Bermuda mortgage lending market. Over 20 years, under amortised mortgage terms, you will pay back the $400,000 principal plus an additional interest amount of $315,751. That adds up to almost paying for your home twice.
We input an additional month of $100 ($1,200 annually) amount above and beyond the normal monthly payment. We earmark this payment specifically to be applied for reduction of the mortgage principal only. And we see the savings: $100 per month ($1,200 annually) saves more than $19,000 in interest, as well as one less year of payments on your mortgage. How about $300 ($3,600 annually) to save $60,000 in interest on the mortgage and final mortgage payment in 16.5 years instead of 20 years?
End of part 1. Apologies, readers. I am out of my allotted space in the Personal Finance column. I assure you that I will be up loading much new material on my website, so that you can read these extended columns in one piece.
Part 2 — Finding the Surplus Cash. Ask yourself and your family a hard question. Can you find some and will you really miss that money?
Also, next week — learning to feel comfortable with free mortgage calculating software, and using it to track you mortgage payments every single month. Watch the application of those payments like a hawk to avoid disastrous results, and understanding how amortised mortgages work.
Confused, feeling a bit math mortgage overwhelmed? Can't figure out what is going on with your mortgage? Drop me a line with your questions. Your personal information will be treated, as always, with the utmost confidence.
I will devote an entire article to answering these questions. Please do take the time to write to me.
Martha Harris Myron CPA CFP JSM Masters of Law: International Tax and Financial Services, Summa Cum Laude
Appointed to the Professional Tax Advisory Council, American Citizens Abroad, Geneva, Switzerland
President: The Pondstraddler* Life™ Consultancy providing international financial planning for the challenging lifestyles of multinational individuals and their families residing, working, crossing borders, and straddling ponds in the North Atlantic Quadrangle. Specific focus for residents of Bermuda, the premier international finance centre. www.marthamyron.com Contact: email@example.com