Companies that offer mortgage plan’s

Question

A generalised question really, which you may not be able to answer as you don't have all of the specifics. Companies that offer mortgage plan’s, this is where they claim to reduce the number of years significantly that it will take to repay an existing mortgage that you have, by totally restructuring it and not necessarily increasing the repayments.
Just wondering if you are aware of any known pitfalls with these, as it sounds too good to be true and you know what they say about that.

For example they can turn a $230,000 mortgage over a thirty year period into a nine year period with not increasing the repayments, but it is using $25000 of savings that I have to invest into it, whereby reducing the amount of interest that you pay by hundreds of thousands of dollars.

Answer

The idea of maximising the repayment speed of your mortgage is certainly a desirable objective. However the objective and the outcome are sometimes unfortunately, not common bedfellows.

The reason is really to do with discipline. To really make the best use of your funds available and to make your mortgage repayment more painless is just based around cashflow management. Making the very best use of free credit periods and paying your household accounts with immaculate precision.

There are any number of programs promoted to assist you in achieving this goal. Many come with hefty fees, among the most spectacular was a group calling themselves ‘Mortgage Eliminators’ some years back where for a fee of around $3,000 or more they would show you the secret.

What they failed to disclose or overlooked was the fact that you;

• Could arrange yourself, with your mortgage provider, a revolving credit facility or a split type loan with ability to repay and redraw a portion on demand daily
• Pay or transfer all of your income from all sources to that account
• Pay your monthly bills with precision as above
• Use a credit card with an extended ‘interest free period’ for most all other purchases
• Sweep the credit card account to zero on the very last day of grace

Thereby reducing the daily balance of your mortgage for the maximum possible period over a given month, thereby reducing the interest applied, in turn thereby reducing significantly the period, thereby the total repayment sum of the mortgage.

The other bit they forgot was that if you had the discipline to manage your cashflow so minutely, so precisely, so carefully you also most likely could work a simple Microsoft Excel spreadsheet or Microsoft Money program to do the same thing for next to nothing. Why would anybody including you, pay their exorbitant fees?

Just do as above and ‘he-presto’ it works, but as said few folk have the discipline to really do what is mathematically possible.

You also note that you are being encouraged to add your $25,000 savings to the mortgage reduction plan.

This issue is one of the great mysteries of financial life for me. We continue to see folk that have a typical residential mortgage on their property. Pay this with complete reliability and yet have some form of cash or savings account savings or worse a superannuation type plan of some sort and don’t understand the tax disadvantages of this strategy.

To briefly explain; in New Zealand a mortgage for residential purposes (not investment) is repaid with tax paid income, that is you earn your $1.00, tax is deducted and you then apply what is left to the repayment, for example if you are a 21.5% taxpayer to net $1.00 in your hand you need to earn $1.28 or the other way, your $1.00 of income after tax becomes only 79 cents.

Now take your investment. For argument lets say you are earning 8.00% per annum gross (pre-tax) and your mortgage just happens to be the same 8.00% rate.

The pretax equivalent you would need to earn to net 8.00% (the mortgage rate) is plus the 21.5% tax being 10.20% per annum. But wait, you are only earning 8.00% on the investment so after tax you are only receiving 6.28% per annum.

You are just doing yourself out of a neat 3.92% per annum by thinking you have an emergency or saving fund set aside. If the savings are in a lower earning account or higher taxed plan the sums are just much worse.

 My advice; Pay the mortgage down but ensure you have the right of redraw (without fee) if you need.

You can very easily employ most or all of the above suggestions yourself with huge benefit to your mortgage terms. Just put the spreadsheet plan in place and have the discipline. You might not save hundreds of thousands but you certainly will save a lot without a huge fee – good luck.

Original Article published August 2005