Don’t just take it from me and from Dave Ramsey. We think the mortgage accelerator program sold by United First Financial for $3,500 is a waste of money. We’re pretty smart, but are there other smart people who agree with us? YES!
Jack M. Guttentag is Professor of Finance Emeritus and former Jacob Safra Professor of International Banking at the Wharton School of the University of Pennsylvania (one of the world’s best graduate finance programs). He is the former Chief of the Domestic Research Division of the Federal Reserve Bank of New York and formerly on the senior staff of the National Bureau of Economic Research. Jack says:
The United First Financial plan, called the Money merge Account or MMA, is a variant that does not require that you take a mortgage from them. The MMA assumes you already have a first mortgage, and it guides you on opening a second mortgage in the form of a home equity line of credit (HELOC), which plays a central role in the scheme. Here is an example which I have over-simplified to reveal exactly where the savings come from and how much they are likely to be.
Assume the borrower’s monthly paycheck is $8,000, and on the first day of the month he does the following: a) Draws $8,000 on his HELOC which is used immediately to reduce his mortgage balance, and b) applies his paycheck of $8,000 to pay down the HELOC. On day 2, therefore, his HELOC balance is zero and his mortgage balance is lower by $8,000.
As the month progresses, he pays his expenses by drawing on the HELOC, and the HELOC balance gradually rises to $8,000. However, the average balance will only be about $4,000. For the month as a whole, therefore, he has saved interest on $8,000 of the mortgage while incurring interest on $4,000 of the HELOC. Assuming both are priced at 6%, he has saved $4,000 x .06/12, or $20. Over a year, that adds to $240. Of course, if the paycheck is $16,000 instead of $8,000, the number will be $480, and if the paycheck is $4,000 the number will be $120.
For several reasons, these calculations over-state the savings. The HELOC as a second lien will almost always have a higher rate than the first mortgage. Further, it will take some days for the borrower’s paycheck to be credited to his HELOC. Finally, and most important of all, the date when the mortgage is credited for the extra payment depends on the policies of the lender servicing the mortgage. In some cases, a payment will be credited to the balance at the end of the preceding month, which works to the borrower’s advantage, but in other cases, credit is not given until the end of the current month, which would reduce and perhaps eliminate any savings.
Note that a one-time payment of $3500 on a 6% mortgage would save $210 of interest a year. This is probably more than most borrowers would save using the MMA.
Of course, if you spend less than your paycheck and apply the balance to your mortgage, it is a different story. The claims by UFF that you can pay off your mortgage in 1/3 or 1/2 the time, depend on your doing exactly that.
Based on everything I know, I have considerable confidence in my main conclusion, which is that the bulk of the reduction in interest payments comes from the borrower’s savings rather than from the program mechanism. The borrower who allocates 10% of income every month to principal reduction is going to reduce interest payments and shorten the life of the mortgage, and no special program is needed to do this.