Ways to speed up the mortgage burning
If inflation won't help homeowners build up their equity, what will? With real estate prices moving up only 3 or 4 percent in many parts of the country, you can no longer depend on inflation to push up the value of your house and supply a bunch of equity to use on the next house.
For a lot of people, the answer is some form of accelerated payments that build up equity faster and give ``free and clear'' ownership in 15 to 18 years instead of the usual 30.
One method, prepayments, has always been available, but it is being used more now when people find they have extra money that can be used to reduce the outstanding principal on their mortgage.
A second method, the 15-year mortgage, got renewed attention about a year ago and has become more popular since then. Here, a home buyer agrees to make somewhat higher monthly mortgage payments and the loan is paid off in half the time.
The third method, the biweekly mortgage, is so far being talked about more than it's being used, but many lenders are looking at ways to install it. In the biweekly, payments are made every two weeks instead of once a month. More-frequent payments mean the principal gets cut down faster. Also, by making it biweekly instead of semimonthly, the lender receives the equivalent of an extra month's payment every year. These two changes combine to get a mortgage paid off in about 17 years.
``We're seeing a new attitude in this area'' of debt, says John Sousa, president of the Commonwealth Mortgage Company in Boston. ``People are saying, `I don't want to be in debt anymore.' ''
Paying down mortgages faster goes along with the Reagan administration's ``grand design,'' agrees Ralph Presutti, a financial planner with the Advest brokerage in Hartford, Conn. By keeping real interest rates -- the interest rate minus the rate of inflation -- ``absurdly high,'' Mr. Presutti contends, the government is encouraging people to carry less debt.
``People are being told to build up equity, pull in their horns, get their debts under control,'' he says.
For people with existing 30-year mortgages, the easiest way to build up equity is to send in some extra money now and then. Most mortgage statements have a space that says something like ``extra payments to principal.''
If you do send in an extra payment, you should use a separate check from your regular monthly payment. Clearly indicate on the back of the check that it is intended for an additional principal payment. This way, when the canceled checks come back, you'll have a record of the transaction. Also, when you get your next month's statement, make sure you were credited with the payment on the bank's records.
If you only make an occasional prepayment, the bank probably won't refigure your monthly payments every year. But if you do this frequently, the smaller-than-planned outstanding debt should result in a decrease in regular principal and interest payments.
The growth of the 15-year mortgage has surprised and pleased lenders who like to see loans paid off sooner and have found this type of mortgage sells well in the secondary market, bringing in money for future loans.
``We have definitely stepped up activity on the 15-year product,'' says John Battaglia, vice-president for residential lending at the Boston Five Cents Savings Bank. In a recent week, Mr. Battaglia reports, exactly half of the mortgages written by Boston Five were for 30 years and half were for 15 years. And in the ``jumbo'' category of mortgages over $115,300, the percentage of 15-year loans is much higher.
To see how a 15-year mortgage works, take a $100,000 purchase with 20 percent down, leaving an $80,000 mortgage. Assuming a 12 percent interest rate, the monthly payment on a 30-year fixed-rate loan would be $823. A 15-year loan would have an 113/4 percent rate and the monthly payments would be $947, or $124 a month higher.
For many families, the main drawback to the 15-year loan is the heavier monthly outlay. ``Make sure you can handle the higher payments,'' Mr. Presutti says. While prepayments are something you can do when you have the extra money, he notes, the 15-year mortgage is a ``contractual thing.'' There's no backing out of it, unless you refinance and pay all the expenses that involves.
To make sure you can handle the higher payments, lenders will ``qualify'' you at both the 30-year and 15-year schedule.
Many of the 15-year mortgages being written are not for home purchases; they are for people refinancing existing 30-year loans. The mortgage is either several points above the current rate and the homeowners want to refinance, or the family has more money coming in now and it can handle the higher payments.
The third form of accelerated payment is the biweekly mortgage. The reason this has not caught on is the extra bookkeeping. Banks are geared to sending out statements and receiving payments on a monthly basis. To have a monthly and a biweekly system has been just too much for most bankers. At City Savings Bank in Meriden, Conn., where bank president Robert Montgomery claims to have introduced the biweekly to the United States (it originated in Canada), it is the only kind he has.
Also, to keep paper work to a minimum, no statements are sent out. The payment is automatically deducted from a checking or savings account. If the homeowner wants to make it even easier and the employer goes along, a paycheck can be deposited automatically in one of these accounts.
So far, Mr. Montgomery says, about 500 banks and thrifts are offering biweekly mortgages. Many of these are small institutions, so you may not be able to find one in your area yet. That would leave prepayments and the 15-year mortgage your best -- and only -- alternatives for arriving at Mortgage-Burning Day sooner.