Equity Acceleration Programs – Are they better for the borrower or the bank?
July 4th, 2007 by Mark Flanders
This is America where the Need for Speed is ingrained from childhood. As children, we want faster bikes and faster Playstations. In our teen years, it’s faster cars and faster computers. And, as adults we want faster promotions, quicker increases in our credit limits and quicker pay raises. Eventually, we all have a day when we decide what we want more than anything else is Faster Equity Accumulation in our home!
The Good
Enter Equity Acceleration Programs. These programs are a masterpiece of marketing. They target the American need for speed promising to shave years off your mortgage and saving you tens of thousands of dollars in the meantime. Both of these goals are worthwhile. And there is nothing wrong with effective advertising. This article is not meant to imply that Equity Acceleration Programs are all bad. They are not all bad. They are poorly explained and even more poorly understood. As with many of the articles on SoundBiteBlog, this article’s intent is to explain the risks (yes, there are significant risks) and expose that the average consumer can accomplish the same goals in the same amount of time, for less money by avoiding the most heavily promoted Acceleration Programs available today. In short, the goals are worthy, the sales pitch is suspect.
The Bad
Equity Acceleration Programs are often explained in a misleading fashion. Rarely is a consumer told boldly that they are trading their nice, safe fixed rate first mortgage for an Adjustable Rate Line of Credit! The reason for this deception is obvious. It’s old news that interest rates are rising. It’s old news that they are expected to continue to rise in the near future. This old news causes anxiety in many borrowers and because of that anxiety, many loan originators are glossing over the part about an Adjustable Rate, preferring to concentrate most of their explanation on the exciting prospect of paying off a loan in a shorter period of time regardless of how it is done.
Fuzzy math seems to play a big part in an Equity Acceleration presentation. I have listened to two of these presentations in the last couple of months. The more aggressive presentation spent considerable time attempting to convince me that my (imaginary) 6.125% Fixed Rate Mortgage, was actually costing me 65%! My questions about interest rates vs. A.P.R. and how RESPA regulations affect us all, were quickly bypassed and never answered. Shock tactics are normal from what I can see.
The realities of these programs are these. You are going to trade your current mortgage (often an attractive fixed rate) for a new Line of Credit (also a mortgage) with an adjustable rate. You will then “deposit” your entire pay check into this “account” each pay period. Payment of all your normal bills is made from the “account” as you would normally pay them. Presto, abracadabra and your new mortgage will pay off years earlier than it would have! This mathematical magic was explained to me as follows. When you deposit your paycheck, you are temporarily reducing your mortgage balance. This temporary reduction reduces the amount of interest that is charged thereby making a drastic change in the overall amount of interest that accumulates on the loan.
The first flaw in the sales presentation for Equity Acceleration Programs is the fact they ignore how most of us pay our bills. Like my mother taught me to years ago, I pay my bills first on payday along with making my deposit to savings. The result of paying my bills immediately is that my new mortgage is only “temporarily reduced” for a very temporary time indeed. The amount of interest saved by reducing my mortgage balance by a few thousand dollars for 2 days is pretty insignificant. AND I had to trade my fixed rate mortgage for an adjustable rate to do it! The positive effect is more than offset by that fact as soon as interest rates rise and my new mortgage rises with them.
Another flaw is that because this is not an actual depository account, you will never be able to earn interest on your deposits. Remember, it’s a line of credit (a debt) not a savings account or a checking account that pays interest. Therefore, money that you could have accumulated by using the same theory with your existing accounts will be lost.
And the final flaw in these presentations becomes apparent when you consider how long it will take to recapture the cost of the new loan itself. You didn’t think these were loans without fees did you? No, like every other mortgage you have applied for, there are fees involved. Someone will need to appraise the home. Someone will need to do a Title Search and approve Title Insurance. And the list goes on. Each service includes a fee. All the normal mortgage fees will apply and they will add up to thousands of dollars. It will take a long time to save enough with the new mortgage to simply break even after these fees.
The Ugly
The biggest advantage to many Equity Acceleration Programs is to the Lender and the Loan Officer. Let’s be pragmatic for a moment. When was the last time you saw anyone advertising anything they were not going to profit from? These programs are no different. The Lender will be make a profit on each and every one and the Loan Originator will be paid for finding another client. There is nothing inherently wrong with that. Each time I have applied for a new mortgage, I knew that Loan Officer would get paid and the Lender would make a profit. Don’t forget, this is just another mortgage and it works like all the others. Loan Originators do not work for free. Lenders work for a profit. The market has gotten very difficult for Loan Originators and many are looking for new, creative ways to generate new loans. Lenders are rolling out “new” creative loan programs and dusting off old ones.
Caveat Emptor, “let the buyer beware”, is a phrase to keep in mind if you are tempted by a good sales pitch. Remember, you are buying a product. You may have just heard about the best product, or you may have just heard the best sales presentation.
The Do-It-Yourself Equity Accelaration Program
If you spend lots of time with a calculator in your hand like I do (occupational hazard), you get in the habit of running “What If” scenarios. It can be addicting to look at how much money we can save by tweaking the numbers in our personal finances. What if I move $2500 to this credit card account over here? What if I send an additional $125 each month in on my mortgage. What if I send that same $125 in on my car payment? You get the picture. This kind of thinking will drive some people to visions of Tequila and others chase the possibilities with all the fascination of a new video game.
What you will find running “What If” scenarios is that there are ways to shave years off your mortgage and save thousand of dollars without having to create a budjet that leaves you depressed for lack of fun money.
Here’s just one idea of many. Rather than opting for an Equity Acceleration Program that will cost you money, open a savings account or a checking account that pays interest. The last time I checked, Boeing Employees Credit Union was open to anyone living in Washington State and had a savings account that paid 5.5%. Now that makes all kinds of sense! Keep your nice, low interest rate, fixed rate mortgage alone. Open a high yield savings or checking account and follow the same principals as the Equity Programs. Deposit your paycheck into it and pay your bills out of it. Make some interest for yourself.
But don’t trade your fixed rate loan for an adjustable rate line of credit without understanding the risk you are taking. Very few Equity Acceleration Programs benefit the borrower as much as they benefit the Lender and the Loan Officer.
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Steering is the practice of guiding a potential buyer towards an affiliated or related Lender, Title Company or Insurance Company. Steering reduces a buyers access to fair representation. Many home buyers have an existing relationship with a Realtor® they trust, or a Loan Officer they trust. Yet, when the buyers attempts to pruchase the property of their dreams, they are confronted with the information that, if the do not use the builder’s chosen Real Estate Company or Lender, they may be penalized in the form of Higher Earnest Money requirements and additional pre-qualification demands.
Wait a moment. Let me back up a bit and give you some details first.
There is a curious and distasteful dynamic that sometimes happens when an elderly couple or individual attempts to get a reverse mortgage. A loan officer is often witness to the greedy side of human nature. The adult children of elderly parents can be cruel and grasping. They view reverse mortgages as something being stolen from them. They treat their own parents as the thieves.
I detest Option ARMs! In my opinion, they are nothing more than the legalized pillaging of American home equity. Lenders with enormous advertising budgets promote them in a fashion similar to old-fashioned used car salesmen. They hook consumers with thoughts of low payments for expensive homes. Or, low payments on refinance transactions. The disclaimers on the television would make an eagle squint. And they are gone faster than the fastest speed reader can read. Of course when a consumer calls on the advertisement, he or she is connected with a salesperson. Salespeople are not well known for watching over a client’s best interest.
