Richard and Michele Hinkle know that describing the inner workings of the 30-year mortgage on their new south Kansas City home can be tricky.
The Hinkles took out the mortgage five months ago. Unlike most homeowners, they make half-size mortgage payments every other week instead of full-size payments once a month. The lender recalculates the Hinkles’ remaining principal and interest payments after every payment. The Hinkles figure this will cut their borrowing costs by more than 12 percent and allow them to pay off their loan years earlier.
Many homeowners dream of paying off mortgages early. Each month, an estimated 10 percent or more try to add a few extra dollars to the payments due on a traditional 15- or 30-year fixed-rate mortgage.
Now their choices are increasing. More lenders are offering new plans to accommodate a wider variety of borrowers’ needs. And more borrowers are beginning to weigh other investment choices and tax consequences when they calculate house payments.
Richard Hinkle, a home builder and remodeler, and Michele Hinkle, a computer company hiring consultant, subscribe to this new school of thought that’s changing how many Americans buy homes. The Hinkles are using a biweekly mortgage plan popular in California, but not yet widely used in the Midwest, to pay off their mortgage as fast as possible.
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They’re also using sweat equity to keep costs low, plus the profits from previous homes they’ve built or improved to further soup up their accelerated repayment schedule. They figure that, with luck, their new mortgage will be history in just over three years.
“Our goal is to be in the home we want with the mortgage paid off by the time we’re 42,” Richard Hinkle said. “We’re going to make it.”
Brian O’Laughlin’s strategy is to pay as little as possible, even if it means delaying building equity, and use his money more effectively elsewhere.
O’Laughlin’s goal is to free up as much cash as possible for investments, retirement plans, college for the family’s four sons and similar obligations.
O’Laughlin is paying his mortgage on the same biweekly schedule as the Hinkles, but most months he pays only enough to cover the 3.75 percent interest due on his mortgage — and not the principal.
The availability of these interest-only mortgage plans is increasing. Fannie Mae, the nation’s largest mortgage backer, and Wells Fargo Home Mortgage, which estimates it funds about one in 15 mortgages in the United States, are rolling out separate versions of the plan here.
O’Laughlin estimates his plan cuts about $600 a month from what he would pay for a comparable 30-year fixed-rate mortgage and provides added flexibility. Like the Hinkles, he opted for an adjustable-rate mortgage because initial costs are lower.
“But there are two other pieces of this plan that you absolutely have to do to make it work,” said O’Laughlin, head of The O’Laughlin Group, a Kansas City insurance and investment advisory firm.
First, there are two times a year when paying every other week means three payments will be made during a month instead of two.
“You use those payments to reduce principal,” O’Laughlin said.
The other imperative is equally simple.
“You’ve got to put away what you save,” he said. “You can’t just spend it.”
Lending industry statistics don’t clearly show how many homeowners try to pay off traditional 15- or 30-year, fixed-rate or adjustable-rate mortgages ahead of time, in part because the number fluctuates with economic upticks and downturns.
But the number seems to be growing, said Jay Brinkmann, senior director of the Mortgage Bankers Association’s research and economics department in Washington, D.C.
Borrowers who want to pay off their mortgages faster typically go one of two routes, lenders say.
“Paying an extra $50 each month toward the principal is pretty standard,” said Jim Nutter Jr., executive vice president at the James B. Nutter & Co. mortgage banking organization in Kansas City.
“Or many people simply convert their 30-year mortgage into 15 years when they refinance,” said Kent Manion, a first vice president at Capitol Federal Financial, one of the area’s biggest mortgage providers.
Financial planners and other advisers say it’s often tricky to figure out whether homeowners should pay off mortgages ahead of time if they have the choice.
“The first thing you’ve got to figure is how much your mortgage actually costs,” said Douglas Dunham, a certified financial planner and president of Dunham & Associates Inc., a fee-only financial planning firm in Overland Park, Kan.
A middle-income taxpayer in the 28 percent bracket with a 9 percent mortgage, for example, actually pays only 6 percent interest on a mortgage after federal and state tax savings are calculated.
Next comes the tougher question, Dunham said: Can you beat that by doing better in the market, after taxes?
Predictably, opinion is divided.
“All these things — our mortgages, our income, our investments — are tools we use to reach our goals. None is really good or bad. They just provide a function,” said Dean Russell, a certified financial planner with Waddell & Reed Inc. in Kansas City.
Others favor paying off mortgages faster, particularly if retirement or some other potentially big income change is near or if homeowners simply want the security of a paid-up mortgage.
Sharon Dwyer, a certified financial planner and founder of Planning Plus, in Leawood, suggests checking a calendar before making final decisions.
Even though mortgage rates are low now, it’s difficult to count on better investment returns unless your money will be in the market at least five to seven years, she said.
“If you plan to retire before then, it’s often better to have your assets, such as your home, paid for,” she said.
More surprising, perhaps, is that many advisers broadly agree that both hares and tortoises win this particular marathon.
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“Ultimately, it’s never a bad idea to pay off debt,” said Tim Shmidl, a certified financial planner and principal with Prism Financial Group LLC in Overland Park. “The question is simply what’s the most effective way to do it.”
Home buyers such as the Hinkles who decide that fast is the most effective choice are big fans of biweekly payment plans.
These plans call for the homeowner to make half a normal monthly mortgage payment every other week instead of one full payment each month.
That works out to 26 half payments, or 13 full months of payments, each year — enough to shave six to seven years and thousands of dollars in interest costs off a traditional 30-year loan.
Some lenders add features. Community Capital Mortgage in Kansas City, for example, offers its borrowers a plan from World Savings in Oakland, Calif. This plan re-amortizes the loan — basically recalculating the principal and interest ratios for subsequent payments — each time a two-week payment is received.
Tying this feature to an adjustable-rate mortgage helps borrowers build equity faster and pay off mortgages sooner with monthly payments that are about 40 percent lower than for a traditional 30-year fixed-rate mortgage, said Kenn Williamson, Community Capital’s senior mortgage specialist.
Borrowers contemplating a biweekly loan need to be aware of a couple of potential problems, said Kern Lewis, loan-marketing director at World Savings in Oakland.
First, the division of payment between interest and principal is extremely flexible, so borrowers need to work with their loan officers to make sure their proposed payments will pay off the loan fast enough.
Second, “Be sure to work with your lender, not a third party,” Lewis said.
Outsiders who would set up a plan, collect the money and forward it to your lender may charge extra fees that eat too deeply into the potential savings, he said.
Most borrowers with traditional monthly payment schedules don’t even need to convert to a biweekly plan to reap most of the benefits, said mortgage banker Nutter said.
“Simply make one extra payment a year,” he said. “Just make sure there are no prepayment penalties first.”