Your Mortgage : Why Extra Payments Can Pay Off

QUESTION: I am puzzled about your sometimes conflicting advice. You tell home buyers to always make the smallest possible cash down payment and obtain the largest available mortgage.

But then the next week, in answer to another reader’s question, you say it is a good idea to make extra principal payments to speed up the mortgage payoff. This doesn’t make sense.

ANSWER: Yes, it does. Uncle Sam’s 1987 Tax Act changed the rules for home mortgage interest deductions. Effective in 1988, home buyers can only deduct the interest paid on a mortgage up to $1 million used to acquire their principal residence, plus a home equity loan up to $100,000. Any interest paid on other loans secured by the residence is not deductible on your federal tax returns.

Home buyers who make a big down payment and take a small or no mortgage only can correct their mistake by obtaining a home-equity loan of up to $100,000.

Interest paid on additional financing, such as a refinanced home mortgage, is not deductible on the amount above the original acquisition mortgage, plus $100,000.

Incidentally, home loans in existence as of Oct. 13, 1987, are “grandfathered” and are considered acquisition mortgages.

I hope that explains why I recommend obtaining the largest available home mortgage at the time of acquisition.

The second part of your letter questions the wisdom of making extra principal payments each month to pay down your mortgage faster. For example, if you have a $100,000 home loan at 10% interest for 30 years, your monthly payment is $877.58.

However, if you add $197.03 to each monthly payment, you will pay off that mortgage in just 15 years, thus saving 15 years of interest payments. By paying $197.03 extra for 180 months ($35,465.40 toward principal reduction), you will save $122,499 in interest.

This shows why it is a good idea to make extra principal payments to speed up the payoff of your home mortgage. Although you didn’t ask the question, you are probably wondering if it is smarter to take a 15-year mortgage rather than a 30-year loan. The answer is no, unless you are absolutely certain you can afford the increased monthly payment. Otherwise, take the 30-year mortgage, but pay it off as if it were a 15-year loan. Should you encounter financial difficulties, then you can reduce your monthly payments back to the 30-year payment rate.

Impound Accounts Source of Trouble

Q: As vice president of loan servicing for a major mortgage company, I think you should be aware the property tax and fire insurance premium escrow impound accounts we handle are as big a pain for us as they are for the borrowers who often write to you to complain about lender overcharges.

I suggest you warn borrowers that they do not voluntarily have to sign up for impound escrow accounts. Impounds are required, however, for VA, FHA and PMI (private mortgage insurance) mortgages. From the lender’s viewpoint, these accounts are very troublesome, but also extremely profitable because we pay little or no interest on them. Frankly, they are rip-offs for the borrowers.

A:: Thank you for your very valuable letter. I constantly receive complaints from borrowers about mortgage lender mix-ups, intentional or otherwise, which cause endless grief. Your honest evaluation of these troublesome accounts should be fair warning to borrowers who are not required to have escrow impound accounts for their property taxes and fire insurance.

When Is Home-Equity Loan an Advantage?

Q: I owe about $7,000 on my auto loan, $14,000 on various credit cards and around $12,000 on a personal unsecured bank loan. My home mortgage is at 9.75% fixed interest, but I have about $60,000 equity in my residence. Do you think I should refinance my first mortgage or get one of those home-equity loans to pay off my various little loans?

A: You have a very desirable first mortgage, so I would leave it alone. A home-equity credit line could serve you well. You can use it to pay off all your personal loans. Since the total is well below the $100,000 home-equity loan limit for federal tax interest deductibility, you will be able to deduct the interest. The nice thing about home-equity credit lines is you get a checkbook and can borrow or repay as you wish.

Questions and comments may be sent to the Real Estate Editor, Los Angeles Times, Times Mirror Square, Los Angeles 90053.