October 12, 2012

“I have a mortgage payment concept that I call "free foreclosure insurance". My concept is to make mortgage payments every three weeks.  I would make the payment due Feb 1 on Jan 24, the payment due March 1 on Feb 14, and so on. This would save me thousands in interest and pay my loan off early.  And if I were to lose my job I could go several months without making a payment and not have to worry about being foreclosed on…, what do you think of this idea? 

I had two thoughts. The first is that your scheme won’t work. The reason is that you have a monthly accrual mortgage, which means that payments on your mortgage are credited as of the first day of every month, regardless of when they are received. This includes late payments so long as they are received within the grace period, which is usually 10 days. So your payment on January 24 will be credited on February 1, and your payment on February 14 will be credited on March 1. You save no interest, and do not pay off early. What you are doing is having the lender hold your money until the payment due date.  

There are only two possible benefits from doing this. One is the peace of mind that comes from knowing that you are paid up for some months and could skip a payment if you had to. But you could get the same peace of mind if you made your payment every 3 weeks into a segregated deposit account, and drew checks against the account every month to pay the mortgage. Then at least you would earn the interest on your money instead of the lender.  

The other possible benefit occurs at year end, when you might claim a larger tax deduction on mortgage interest paid during the year if you can induce the lender to record your advance payments as having been made that year, even though the payments have not yet been credited to your mortgage. A few borrowers manage to do this, but their lenders usually draw the line at 2 extra payments.  

But after writing the above, I had another thought. Would paying every 3 weeks generate the benefits you seek if your mortgage was simple interest?  The answer is “yes”.  

Simple interest mortgages (SIMs) accrue interest daily instead of monthly, and payments are credited as of the day they are received. I have written about SIMs in the past, warning borrowers that if they have one, they better pay on time or early. If they pay on the 10^th of the month, it will cost them another 10 days of interest. The borrowers who have written me about their SIMs were not aware of what they had, and were paying more interest and less principal than if they had had a standard monthly-accrual mortgage. That’s why I called SIMs “a trap for the unwary.” But I did not consider until now that it could be a boon to an astute and disciplined borrower.   

Unless the SIM lender imposes a limit on the number of payments a borrower can make, the three week payment approach would work like a charm. To test it, I used the simple interest spreadsheet on my web site to see what would happen if every 21 days. I made the monthly payment of $599.56 on a 30-year 6% SIM of $100,000 . What happened is that I paid off the loan in less than 15 years, and cut the interest bill by 58%. The details are shown below.  

Days to Payoff and Total Interest Payments on a Standard Monthly Accrual Mortgage and a Simple Interest Mortgage of $100,000 for 30Years at 6% 

	Days to Payoff	Total Interest
Standard Mortgage, On-Time  Payment	10,958	$115,832
Simple Interest Mortgage
Payment on First Day of Month	10,990	$116,167
Payment 10 Days Late Every Month	11,059	$117,160
Payment Every 21 Days	5,229	$49,183

Can a monthly accrual mortgager be converted to a SIM so as to accommodate the 3-week payment scheme? Some lenders in the past have converted mortgages to SIMs without the borrower’s knowledge, where the note permitted it, as a way of extracting more interest from them. I doubt that any lender would be interested in converting to accommodate a borrower who wanted to use the SIM to cut their interest bill. But hey, it doesn’t cost anything to ask.  

The broader question is whether the SIM should be available to every borrower as an option, with full disclosure of the potential pitfalls and benefits.