I was talking with Matt Roberge ofSLC Bookkeeping about my blog post yesterday. We had a great conversation and he made some great recommendations, so here’s my follow up post thanks to Matt:
Let’s first start by going over what Ramit Sethi’s concept is in “Have a mortgage? Save $71,000 in interest payments” and please correct me if I’m wrong. Ramit talks about using a bi-weekly payment schedule. The reasoning behind this is that most people are paid bi-weekly and it even works if you are paid weekly. With a bi-weekly payment schedule you would pay half your mortgage every 2 weeks. The dilemma with this, as the comments to Ramit’s blog bring attention to, is whether your bank will allow you to do this or charge a fee or whatever. I’m not going to address this hear because the most important part is not necessarily paying every two weeks but it is instead the fact that this strategy uses 26 half payments a year. This means that you make 13 monthly payments a year rather than the usual 12 and this is where the majority of interest savings is. Ramit’s concept is paying that extra monthly payment to your bank or mortgage company allowing you to lower the principal and reduce interest.
As my last post referenced, this is what the banks/mortgage companies want you to do. How do banks make money? They make it off of your money. They want as much of your money as possible as quickly as possible. If we have learned anything from the current economic situation it should be that banks don’t keep money on reserves, they send it right back out the door in hopes of make more money. This also give control to the banks. If you have a mortgage and you want to do anything with your house, apart from selling it, you need to ask the bank. The bank decides if and how much of the value (equity) in the house you can access. If something changes with your financial situation (job losses anyone?) the bank can and will say ‘no’. Not only can they say ‘no’ they can take your house regardless of what you’ve put into it. If there were two of the exact same houses right next to each other and house A had $250,000 left on the mortgage and house B had $50,000 left on the mortgage which do you think the bank would foreclose on first? Think about it from a business perspective.
So that being said, I think the bi-weekly payment schedule is great. My concern is sending that extra monthly payment to the bank/mortgage company. Why not take control of that money yourself? Ramit seems to imply in the comments section that he feels most people aren’t able to be disciplined enough to do this. Then follow Ramit’s own advice and automate it to another account. The biggest question becomes where to put it.
Some people will argue for putting it into the stock market. Their reasoning is that mortgage rates are near historic lows and over the 20+ years you have the mortgage the stock market should average some rate of return that is better than your mortgage rate. Arbitrage. The concept is sound. My concern here is two fold, one, it can be difficult to control taxes with these investments and more importantly, two, you might not get a good rate of return. Yes I said it. The stock market can loose money. Everyone realize that now?
So what do we need from a savings vehicle to make this work? To make it a more viable options you would need safety, liquidity and a rate of return equal to or greater than your tax adjusted interest rate. You also need to have a way to manage the tax implications of this savings vehicle. You don’t want to have the compounding interest become a compounding burden (check back for this blog post soon). So let’s start the discussion here…what do you know that has safety(rules out most market related investments), liquidity(rules out CDs, real estate, business ventures) and rate of return (rules out CDs again and money market accounts). So what’s left? Does it work? I’ll be happy to do the math for you if anyone has a scenario. The answers to these questions can really vary depending on your situation. There is no right answer for all here, sorry.
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Great follow up CJ. Thanks for making it really clear. Now everyone should have a full understanding of what is going on here. I’m not sure I have an answer to your question but I do believe there is one out there for everyone. I think finding the answer will require an in depth look at each individual’s situation…enter CJ.
If anything this article should make people think “the correct” way when it comes to their financials.
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