Mortgage Payoff Acceleration Calculator and Example
Does mortgage acceleration work? How can you more efficiently use your paycheck to accelerate mortgage payoff?
Use offset accounting to make interest while offsetting or reducing the balance of another account.
So, for instance, you have a bank account where your paychecks are deposited earning no interest. If you also have loans accruing daily interest, wouldn’t it be nice if your paycheck offset the loan and thus decreased the amount of interest owed?
Let’s look at how offset accounting is used in mortgage acceleration and calculate the savings!
Principals of Offset Accounting as Applied to Mortgage Acceleration
Your bank makes profits by taking your money and lending it. This is interest rate arbitrage.
When you deposit your paycheck into your checking account, they pay you 0% interest (or close to it). Meanwhile, banks take your money and loan it out. Say they loan it back to you as a mortgage. Well, then they win on both sides. They have your liquid cash for free and you pay them interest on the mortgage.
Sure, you can use a savings account at your bank and get ~0.1% interest. Or, you can use a high-yield savings account at ~2%. Even still, you are paying ~4% on the mortgage.
The bank makes money on both sides of interest rate arbitrage. What if you could interrupt the cycle, and have your paycheck immediately go to accelerate your mortgage debt and thus earn 4% rather than zero?
This is mortgage acceleration
Don’t Spend Money on Mortgage Acceleration, Save Money on It.
By now, alarm bells should be going off in your head. SCAM ALERT!
Good for you! Now, understand that I’m not trying to sell you anything.
You can, of course, find schemes, books and apps that will charge you money for this “magic pill.” Online mortgage payoff acceleration calculators abound.
Frequently called Equity Optimization, Velocity Banking, or one of many other names, these are often remakes of old MLM (pyramid scheme) products. They are always being reborn: now, as seen on the internet as get-rich schemes. Don’t by the schemes. Literally don’t buy them!
But mortgage acceleration works.
If you can get your money working immediately for you (and not have to pay to do so), wouldn’t that be worth it?
How to Immediately get your Paycheck Working for You?
Offset accounting aims to put your paycheck to work immediately; this is acceleration of mortgage.
Normally, a check from your employer drops into your bank account every two weeks. It then sits there earning nothing, until you pay bills. You can pay the mortgage, credit cards, or other bills.
Meanwhile, the mortgage you pay every month is sitting there accruing interest charges on the principal owed.
How can you optimize the equity in your life? Equity is the amount of something you own above what you owe. You have equity in your home. Some folks think that equity is wasted or “locked-up” and you should never pre-pay your mortgage. The flip side is the emotional pleasure of owning your home outright.
Assume you want to pay off your home early. So, to optimize your equity, you decrease your mortgage. You can do that through mortgage acceleration.
What is Mortgage Acceleration?
Mortgage accelerator and mortgage acceleration are generic terms that describe a programmatic method to pay your mortgage off rapidly.
Mortgage acceleration works because a home mortgage is amortizing loan. This is a fancy way to say you pay the same amount over the term, but the amount applied to your principal (vs interest payments) increases over time.
Mortgages are Amortizing Loans
Above, you can see the amount of interest you pay in blue over thirty years. Note most of the payments in the early years go to interest payments, and there is a slow slope down over time.
Only after about 14 years are you paying as much into equity (principal) as interest. The principal payments in green have a flat slope initially but increase more rapidly in the last years.
There are a couple of lesson from the above. The average home owner sells or refinances after about 7-8 years so their payments are almost always mostly going to interest.
Next, a pre-payment early in mortgage has a larger effect as it compounds over time! You save the 4% on your pre-payment not only the first month you make it, but on every month thereafter! The effects are magnified over time, but especially so early on.
Let’s look at this last point a little more closely.
Early Pre-Payment’s Compounding Effect on Acceleration of the Mortgage
Note above how a single pre-payment compounds over time. The solid red line demonstrates the payoff of the 30-year mortgage. The dotted red line shows the ongoing result from a single pre-payment.
You get compounding growth on your pre-payment! Note how the slope of the pre-payment line drops faster than the original line over time.
How much to you save? It depends on when you make the pre-payment.
How Much you Accelerate the Mortgage Depends on the Timing
See above: the amount of interest you save depends on when you make the prepayment.
For each $100 pre-payment, the interest saved depends on when the payment is made. When you make the prepayment early (at month 1), you save over $200 of interest on your $100 investment. As you pre-pay later in the loan cycle, you save less in interest.
So, now that we know you save more the earlier you pre-pay, and that mortgages are amortizing loans, we can try to understand mortgage acceleration.
How to do Mortgage Acceleration
Stick with me now. This is a bit complicated.
Let’s assume you have a steady job and plan to pay extra on your mortgage. Make sure there are no pre-payment penalties on your mortgage. Also, make sure you know what date your mortgage company will accept a pre-payment as payment on that month’s principal. Every company does that a little different.
Open a HELOC. Learn how to do this. This is not a simple step.
HELOC with a Teaser Rate
If you get a teaser rate that is lower than your interest rate on your mortgage, then pre-pay your mortgage with the amount of the HELOC you can pay-off during the teaser term.
Here, you get the benefit of a large pre-payment early in your amortizing mortgage schedule. Instead of most of your payment going towards interest, you have a large payment of your principal which pays off immediately and compounds over time.
Next, notice that even though your debt is the same (you just traded mortgage debt for HELOC debt), as you pay off the HELOC, the “average debt” you have exposed to interest decreases over time. This is an important concept.
As an absolute rule, you must have positive cash flow to do Mortgage Acceleration. It just doesn’t work without it.
But not all of your positive cash flow goes to mortgage pre-payment. You still need to pay bills.
When you deposit your paycheck in your HELOC, however, you offset your debt! You use money that has another purpose (say date night next week or the electric bill in two weeks) to pay down debt and lower overall interest paid.
You trade a amortizing debt with a simple compounding debt. Effectively, you are using your previously incompetent paycheck to pay down debt.
Instead of earning zero on your paycheck, you offset the simple interest in your HELOC.
HELOC without a Teaser
This also works even if the interest rate on your HELOC is higher than that of your mortgage. This is where most people get lost so I’ll try to explain it.
As an example, take $10,000 out of your HELOC and use it to pay the mortgage.
From that point forward, you get compounding interest savings in your amortizing mortgage.
In the HELOC, you start out with the same amount of debt that is at a simple daily interest rate.
Direct deposit your paycheck into the HELOC. This means the day it hits your account; you are paying on less interest rather than it sitting in your checking account earning nothing. You are getting tax-free interest savings just from paying off your debt!
As you pay down your debt, your average debt being exposed to simple interest is less than the debt otherwise exposed to amortizing interest, saving you money via interest rate arbitrage.
This works even if your HELOC has a higher stated interest rate than your mortgage for two reasons. One, because the average debt is lower. Two, because it is simple interest vs amortizing interest.
How can you make mortgage acceleration even more effective? Using credit cards.
Use a Credit Card to Pay Bills with Mortgage Acceleration
It works even better if you use a credit card.
If you put your expenses on a credit card, you get a 30- to 50-day float. Then you pay off the credit card with your HELOC, allowing you to use the money to decrease your interest charges before it is needed to pay bills.
How Long Should the Payment Cycles be with Mortgage Acceleration?
If you just use a credit card to do mortgage acceleration, you can use on paycheck to pre-pay your mortgage and then catch up with your positive cash flow. Be careful to understand that you need to pay your credit card off monthly otherwise this will not work.
If you use a HELOC, you can pre-pay for 2-4 cycles a year.
Eventually, as you pay off your amortizing mortgage debt, mortgage acceleration doesn’t make sense. After a few years on a 15-year mortgage, or 14 years on a 30-year mortgage, more of your monthly payments go to principal than interest and pre-payment stops being effective. Review figure 3 above to see the return on interest saved with $100 pre-payment.
Does Mortgage Acceleration Work?
Yes of course it does! If you have positive cash flow and plan on paying off your home early, you will increase your net worth more rapidly with mortgage acceleration.
If you want to explore mortgage acceleration, please don’t pay any money for it. Find a Mortgage accelerated calculator online below. There is a downloadable Excel spreadsheet that will tell you how much you can save!
So, how much can you save?
Plug in your own numbers. After playing around for a while, generally you save about 2 months and $3000 over the life of your loan.
Above, you can see the payoff of a 15-year $200,000 mortgage. Blue is without any additional payments.
The red line represents early payoff just using extra principal payments. In green, extra principal payments are made with mortgage acceleration. You can see instead of 15 years, you pay off the mortgage in just over 7 years with either method.
Mortgage acceleration pays the debt off 3 months earlier and saves $3000.
It won’t rock your world, but a small change—or even one or two early pre-payments—can compound over time.