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1 August 2005
"Recently, I heard an ad on the radio about a
new type of mortgage from CMG Financial that allows you to use the mortgage as
if it was a checking account. According to them, this allows you to pay off your
loan in about half the time. Would you give me your opinion?"
Early Payoff
Schemes Abound
Not a week goes by that a reader
does not write me about some new early payoff scheme. They sprout like weeds
because the soil is so rich. It consists of the millions of mortgage borrowers
hoping that a good fairy will come along and show them how to get rid of their
debt more quickly, and with less pain.
If I wrote about every one of these
schemes, I would never have time to do anything else. This one was worth my
time, however, because the central idea is attractive, even though its basic
promise, to shorten the term drastically, is highly questionable. To get that
result, borrowers must save a significant piece of their income every month and
apply it to the balance, which they can do with any mortgage.
How the CMG Plan
Works
The basic idea, copied from a
program developed by banks in the UK and Australia, is to allow the borrower to
use his mortgage as if it were a checking account. His paycheck, instead of
being deposited into a checking account where it might earn interest of 1-2%, is
used to pay down the mortgage balance, thereby earning the much higher interest
rate on the mortgage.
As the borrower spends money � for
example, by writing checks, withdrawing cash from an ATM, or using a bill-pay
service -- the mortgage balance rises. Even if the balance at the end of the
month is the same as at the beginning, the average balance is lower. Since
interest accrues daily on the CMG mortgage, the total interest charged over the
month is also lower.
The amount of interest savings
depends on two things: the size of the borrower�s paycheck relative to the
mortgage balance, and the portion of the paycheck that is saved. The second
factor is crucial in generating large interest savings. If the borrower�s
paycheck is $2,000, for example, and he saves 10%, then the deposit at the
beginning of the month reduces the mortgage balance by $2,000 while spending
during the month raises it by only $1,800, leaving $200 as a permanent reduction
in the balance.
Assessment of the
CMG Plan
CMG has a simulation program on its
web site that allows users to calculate interest savings and term reduction but
the program requires a savings rate of at least 10%. This makes it impossible to
separate the benefit from being able to use the mortgage as a checking account,
from the benefit attributable to use of the borrower�s own savings to pay down
the balance. Any borrower who uses 10% of his income every month to make an
additional payment on his mortgage is going to shorten the term substantially �
whether they are using the CMG program or any other program.
This is a critical issue because
borrowers pay a premium price for the CMG mortgage. It is an adjustable rate
mortgage with a margin that CMG acknowledges is "higher
than on other adjustable rate loans". (There is also an annual fee to defray the
cost of providing transaction services, but a spokesperson for the company said
it was only $40 a year).
Whether a borrower benefits from this
program or not depends on whether the gain
from using the mortgage as a checking
account exceeds the cost of the above-market margin.
There is no easy way to determine this. CMG does not allow users to calculate
interest savings uncontaminated by extra payments, nor does it indicate how far
above the market their margin is.
The CMG plan may discipline
borrowers to save more than they would otherwise, which could be a valuable
feature for some consumers. Forthright merchandising would stress this feature,
rather than implying that the early payoff and mortgage interest savings that
arise from the borrower�s own additional savings are due to the program.
Note also that CMG offers only one
type of mortgage under this program. It is one of the riskier ARMs around
because the rate is adjusted every month based on movements in Libor, a highly
volatile index. This is not a mortgage for borrowers who would have trouble
dealing with rising payments.
Copyright Jack Guttentag 2005
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