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Monday, August 25, 2008
One Extra House Payment Nets Big Cash
Don Taylor
Bankrate.com
Q: Dear Dr. Don,
I have a 20-year mortgage on my house and make roughly an extra payment a year. How many years am I really knocking of my mortgage? My loan was for $220,000 at 5.625%.
-- John Juncture
Dear John,
If you're a regular reader of this column, you know I'm not a big fan of biweekly mortgages. I don't see the need when you can do it yourself and save by making additional principal payments on your existing mortgage.
Making the equivalent of an additional mortgage payment each year gets you roughly to the same point as you'd be with a biweekly mortgage. You can figure it out for yourself by using the amortization feature on Bankrate's mortgage payment calculator.
I used the calculator for your mortgage and, if you've been faithful about making that additional payment every year since the start of the mortgage, your 20-year mortgage will be paid off in 17 years and five months.
That will save you about $21,800 in interest expenses, although that number ignores the tax impact of any lost mortgage interest deduction. (Bankrate's calculator rounds the interest rate up to 5.63%, so the savings and the interest expense aren't exact.)
I assumed that you made additional principal payments each month equaling about 1/12 of a scheduled monthly payment. The calculator gives you other options for additional principal payments.
Bankrate also has a biweekly mortgage payment calculator. I ran your inputs and it showed you saving $22,239 in interest and having the loan paid off in 17.3 years (17 years and four months).
Who needs a biweekly mortgage when you can do it yourself and not make the additional payments contractual?
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Some mutual funds want you to pay for the privilege of them (or your investment adviser) taking your money to invest. It's called a load, and it works like a cover charge to get into a nightclub. Luckily, there are such things as no-load funds. As the name implies, shares of these funds are sold without a fee paid to a broker or investment advisor.
The entire amount you invest in no-load funds goes to work for your returns. On the other hand, with load funds, right off the bat you're charged commission (not to mention other fees incurred over the life of the investment). Let's say, for example, you invest $25,000 into a load fund that charges a 5% commission. This costs you $1,250 off the top, bringing your actual investment down to only $23,750.
The often-cited horse race analogy argues against investing in load funds. Here's the logic behind it: Would you place a bet on a horse that had to start a race 200 yards behind the others? Well, maybe you would if you got a tip from a sketchy, trench coat-clad man in a dark alley. However, under most circumstances, it's not smart to put your money on that handicapped horse.
But some argue that at times that man in the trench coat (aka your broker) knows more about the horses than you do, and has a better shot at picking a winner. Also, sometimes these fees are unavoidable because some funds are available only through investment advisers.
Cost-benefit analysis can help determine when a load fund is worth it (in other words, when it will score you a load) and when it is better to "do it yourself" and avoid the fees. Load-fund fees range depending on share class and can cover a variety of costs, such as paper work and fund management.
