The most recent hot thing in mortgage circles is a mortgage accelerator program. I’ve heard other things, most notably biweekly payment programs, called mortgage accelerators in the past, so let me take a moment to define exactly what I’m talking about.
A mortgage accelerator is essentially a combined mortgage and checking account, where every month you deposit your entire pay, and then write checks out of it as the month goes on to pay for your living expenses, and the mortgage interest of course accrues on a daily basis. The good things about it for consumers (and it is a good thing, as far as this goes) is that the entire paycheck is applied against your mortgage balance on day one, when your pay is deposited. This means that instead of just the minimum monthly payment, your entire pay goes towards the mortgage, lessening the amount of interest you pay in any given month. The bank, for its part, gets your entire paycheck and a significantly lower incidence of default.
This isn’t a new concept. Several banks had somewhat different versions back in the late eighties. It went away. Why?
Several reasons, some administrative, some financial. Basically, consumers wised up. First, the administrative. This bank has basically your entire financial activity. Let’s say someone gives you a better deal. Now you either have to stick with a mortgage accelerator program, or go through the hassle of coming up with enough cash to start a new checking account if you go back to having a standard mortgage. Furthermore, when you do refinance, what happens to outstanding checks? That payoff is as of a specific day at a specific time. Your escrow officer comes in and gets the payoff demand, and then more checks clear and everything has to be re-figured. The alternative to this is freezing the account as is done with Home Equity Lines of Credit. So all of a sudden while you are going through this refinance, you have to come up with the seed cash for a new checking account, get new checks rushed through, and then pay your bills with the new checks. May the Universe Help You if you normally pay by automatic debit or any of the primary variants, because you have to set that up as well.
So what else does the bank get out of it, looking at the above? Increased opportunity costs for refinancing. In short, it makes it more difficult for you to take your business elsewhere. Cha-Ching! as the bank officer’s eyes light up with dollar signs.
Now obviously, this mortgage accelerator saves you a small amount of money, if you assume it’s just a matter of math, and that math shows how much interest you save as opposed to the same loan at the same interest rate, providing you keep money in your checking account, of course. But how many people do? Not that many, these days.
Furthermore, it assumes you get the same loan at the same interest rate that you normally would. I haven’t comparison shopped many of these yet, but my general impression is that the rates, and costs to get them, are higher than you might otherwise get. The assumption that it is the same rate and the same costs on the same type of loan is just that, an assumption, made for modeling purposes. I have used the metaphor of the matador in the past. The bull (consumer) wears himself out on the obvious large red cape, namely the cool service and the fact that all your pay is applied to your mortgage, and never sees the sword, which is the fact that your interest rate is half a percent higher than you might have gotten, you paid an extra point of origination as well, and you’re being dinged $10 per month administrative tracking charges for this cool new toy you just got, the accelerator mortgage. Let’s say your mortgage is $400,000. Half a percent of $400,000 is $2000 extra interest per year. An extra point of origination is $4000. And $10 per month is about what the average person might save on their mortgage interest if they weren’t paying a higher rate, which they are.
($6000 per month deposited, instead of maybe $2500, leaves $3500. You save an average of one half months interest per month on this difference. $3500 at 6% divided by 24 is $8.75. If they bill you $10 per month for the service, you are out $1.25 per month net, on top of the additional interest charges and the one time fee of several thousand dollars of origination)
So lenders with mortgage accelerators charge you more money, charge you more up front costs, and you pay higher interest charges, as well as making it more difficult for the consumer to refinance into a better deal somewhere else. The banks love this one. Only the fact that your parents figured out what a rotten deal most of these are kept them from becoming a permanent fixture of the mortgage landscape nearly twenty years ago.
The vast majority of the benefit of these programs is in the extra money they assume you’ll use to pay down the mortgage, a thing which almost anyone can do for free. Still, if you can find a mortgage accelerator at the same interest rate, for the same costs, and without the monthly or up-front setup fees that you don’t have to pay for with any other mortgage, then YES it makes sense to have one of these programs. But that’s not what most of the lenders are offering. In fact, I’ve never seen one offering that. They are hoping that you are so distracted by the money whizzing everywhere that somehow magically pays your mortgage down, that you won’t consider that their rates and the costs to get them are higher than you’re being offered elsewhere. They hope you’re distracted by their (nonsensical) figures of how much you will save if you keep your mortgage until it’s paid off, that you will never see how much extra you are really paying. Nor do most people keep any given mortgage longer than a few years. In fact, the median time living in a particular piece of real estate is only nine years – less than one third of the time until payoff. The metaphor of the matador is extremely apt. This is precisely what the matador does with the bull. Distracts them and wears them out with the cape so that they never see the sword. The banks dangle this wonderful mathematical concept of what might happen thirty years down the line for that one tenth of one percent of people who actually keep the loan that long and pays extra money while doing it, hoping you are so fascinated by it that you never notice that they’re charging you more up-front fees and a higher interest rate than you would have gotten with a traditional mortgage, and often, more in monthly maintenance fees that you save by depositing all of your pay. In short, the lender is making more money off of you by pretending to do you a favor.
So shop loans by interest rate and cost, and then if they’ll let you put a mortgage accelerator on it for free, great! If not, they’re just trying to distract you from what is really important by offering you a convenience and a cool-looking trick, while charging you hefty amounts of money and tricking you into thinking you are getting something beneficial.
Caveat Emptor
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(This is a reprint from December 2006, with a few updates. It is instructive in the wake of a certain new mortgage quote service, launched with great fanfare. The negative amortization loan is gone, but I’m seeing lots of other fairy tales being told there – deliberate low-balling on costs and payment being most common. Heck, their automated property tax quotes are about half the real number, and there’s no ability to change them.)
I got a question about what I think about those online quote services.
The answer is that they vary from okay to putrid.
There are two sorts of online quote sources. The first is where mortgage companies have their rates online, and people come along and browse. Those are pretty much a waste of your time. Here’s why: Those companies have absolutely no hold and no real tracking on the people who come to browse. They might put a cookie on your machine, but it’s hard to parlay those into contact information, which is their whole entire goal: Getting loans out of it. Unless they have some way of contacting you, which they don’t, they need to use that forum to get you to contact them. They do this by low-balling their quotes, making it look like they are offering something nobody else has. Unfortunately for consumers, that’s not even an estimate. Here in California, the one caveat is that the rate must exist, but the real costs of getting that rate can be many times the costs they quote. This suffers from all of the limitations that a Good Faith Estimate does, plus more. They can say that they’ve got a 3.625% rate, and as long as they have a 3.625% loan, they are in the clear. Never mind that it costs a full six points and adjusts every month, that sounds like a great loan to the uninformed. Furthermore, many places will quote the nominal (“in name only”) as opposed to real interest rate on the negative amortization loan. When there are people apparently offering you 0.5%, that’s who most consumers will call, ignoring the people who have and can really do 5.5% thirty year fixed rate loans, more so on those forums where they include a payment quote as well. I’ve got the same 0.5% nominal rate forty year amortization loan available to me, but it will always be a putrid loan, as the real rate is a little over 8% and the rate is subject to change every month. I should note that lenders pay a lot of yield spread to brokers who do those loans: How often do people sign on the dotted lines for mortgage rates in excess of 8% (with a three year prepayment penalty!) when rates under 5% are available on a thirty year fixed rate mortgage with no prepayment penalty at all? I’ll tell you how often: Whenever people aren’t smart enough to realize that that $960 payment on a $417,000 loan isn’t the real rate. Indeed, they’d have to pay $2794 per month just to pay the interest – while the fully amortized payment on a thirty year fixed rate loan is hundreds less. But there are an awful lot of people who aren’t smart enough right now.
Furthermore, those online forums are supposed to enforce their quotations policies. I’ve never heard of one that enforces real concrete penalties for violators. On two separate forums, I went straight down the line contacting every listed company, using a loan scenario that was close enough to what they were supposed to be quoting to that I should have gotten the same quote or a little bit better, if they could really do those loans. Not once did I get a rate that was within half a percent of the rate listed online, and most of them were over a full percent off, and with negative amortization loans, most are not even in the correct ballpark. When I contacted the forums themselves, neither of them was interested in enforcement.
In short, those online quote forums tend very strongly to get business for the company that tells the biggest, most boldfaced lie. Often, the consumers are lulled by the existence of the forums into thinking they’re getting a deal, and they don’t bother going through the necessary steps to shop their loan around. Meanwhile, the companies that will advertise honest rates quit those forums in disgust. Since there are a lot more companies playing games with their quotes than honest ones, the forum wins by not enforcing their rules. However, since the consumer wants to find companies that really will deliver the loans they advertise, consumers lose. Matter of fact, I don’t think I’ve ever seen a real rate on a loan I would be willing to sign up for advertised in any forum: online, newspaper, or otherwise.
The second type of online quote forum work like the advertisements plastered all over the internet. “$510,000 loan for $1698 per month!” (to use the first I found just now). They show a couple dancing happily, having a party because their mortgage payments are reduced, or so they think. Another shows a guy jumping for joy. What they don’t show is those same people when they figure out all of the downsides to the negative amortization loan that they signed up for. “This is Jack calling his lawyer again, only to be told there’s nothing the lawyer can do again. This is John and Jane losing their home to foreclosure.”
Their come on is that you’re supposed to get four competitive loan quotes. The company advertises negative amortization loan payments because more people will click on them and sign up for the service if they think they might get something so great that anyone would want it. Unfortunately, just like every other negative amortization loan out there, the payment or interest rate they quote to get you to click their ad and complete their form online is not the real payment and it is not the real rate. Yes, they will accept that as a monthly payment. But the interest you are being charged is based upon a rate of 7.87%, and you have to pay $3345 per month just to break even on the interest – that other $1647 gets added to your loan, so that next month you owe $511,647. Doesn’t seem like a lot of extra, but go along for three years until the pre-payment penalty expires, and even if your rate doesn’t adjust upwards, your balance is now $576,600. If you go the full five years that the minimum payments last, you owe $630,000, and now your payment jumps to $4813, and you can’t refinance because you are upside-down on your mortgage, and your credit score is 100 points lower!
The games don’t stop here, by any means. You’ll be told that there are “no costs out of your pocket,” and even though they’ll be rolling $23,000 in costs and points into your loan, they give you a quote based upon the amount of money you tell them you need. No, $23,000 doesn’t make that much difference at half a percent forty year amortization, but it lets them quote that payment just a few dollars lower, even though they know that you want the $23,000 rolled into your loan. Nor is what they’re telling you about a good loan in any way shape or form, but most people shop mortgage loans based upon payment.
Furthermore, they aren’t telling the truth about four mortgage providers calling you. They may sell the lead to four different places, but those four places turn around and sell them to four others each, and each of those sells them to four more. There may be as many as six levels of this going on, and the average person who does fill out their form will be called by at least fifty providers in the first week, with others trailing out for potentially years. The lead seller doesn’t care – they made their money, and they don’t give refunds simply because the loan they talked about is toxic. Nor does it matter to them that the loan they talked about puts the loan providers paying them for leads in the position of either telling people – honestly – that the loan that was used to get you to sign up is a piece of garbage that causes people to lose their homes, or just selling you one of the abominations. They don’t get refunds from the lead seller in the first case; they’re just out the money. In the second case, they get paid roughly 3.75% of the loan amount by the bank ($19,125 on a $510,000 loan), plus whatever points of origination that they can con you out of. Finally, if they don’t, they know that one of the fifty or more other companies that will be calling you will sell you one of those loans. So their motivations are not on the side of telling you the downsides of their loan. Matter of fact, their motivations are never aligned with telling you the downsides of the loan, so if you find someone willing to talk frankly about good and bad, they are a treasure and it is worth keeping their contact information, and making a habit of talking to them first about future loans.
Once upon a time, if you could cut through the morass of fifty or more companies calling, those “competitive quotes” ads were a great way to find a good loan provider. Ethical low cost loan providers could make a very good living buying those leads. Unfortunately, that is no longer the case. First off, ninety-nine percent of the leads you pay for were lured in with the promise of a negative amortization loan. You don’t get refunds for those. You are just out the money, time, and phone expense of calling those folks – unless you make a habit of selling negative amortization loans, which low cost ethical providers do not. Furthermore, even on the few leads that are not lured in by Negative Amortization payments, just because you don’t try and sell them a negative amortization loan doesn’t mean that one of the other fifty companies won’t. Having been there and done that, I can tell you from experience that trying to talk people out of negative amortization loans is usually a waste of breath – the competing company will use conspiratorial tactics like, “That’s because this mortgage is too good – they don’t want you to have it!” People want to believe in Santa Claus, the Tooth Fairy, and Negative Amortization Loans. Bottom line for ethical loan providers: paying these services for leads no longer works. You cannot make any money at it. Since making money is what you’re about, and the payoff is too low to survive on the thin margins of good providers, you are driven elsewhere for your business leads. Since that’s the type of loan provider consumers want, it’s a waste of time to go to either sort of online mortgage quote service.
at this update, negative amortization loans are now long gone, but all of the old standby games are still being played. “Forgetting” about adjusters that apply, lowballing the actual rate/cost, quoting rates for a loan there is no way the people will qualify for, (there’s quite a divergence currently), quoting conforming rates when the loan should be Jumbo Conforming or non-conforming, and forgetting to add the costs to the loan balance when quoting payment. Anything to get you to call.
Caveat Emptor
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