Wouldn't it be nice to have a house, but no mortgage? A mortgage savings account is a relatively new, increasingly popular financial product intended for people who have that dream, but don't want to wait until they're 90 years old to achieve it.
Mortgage Savings Account: How It Works
The first thing to understand about this product, even if it's called by one of its other names of "mortgage interest savings account" or "accelerated mortgage pay-off," is that it's a loan. Repeat: it's a loan. In order to have a paid-off house, you have to pay off the loan. It's a variable interest rate loan, secured by your house, similar to a home equity loan (HELOC). But a mortgage interest savings account acts like a bank account, too.
Let's use an example. You borrow $300,000 to buy a house, and you deposit $50,000 to your new savings account. With a mortgage interest savings account, the $50,000 in savings reduces your loan balance to $250,000. Since a typical mortgage accrues interest daily, reducing the principal on your home loan means that less interest is charged. At a 6% rate, it would take $1,500 to cover the interest due on a $300,000 loan, but only $1,250 on a $250,000 loan. That extra $250 could be used to reduce the principal balance further.
Meanwhile, you would directly deposit your paychecks into the account, which would then further reduce the principal and interest on your loan. Unlike traditional mortgages, where if you make extra principal payments you lose access to your money, you can still use the money in a mortgage savings account today, for other expenses. You can even write checks or make ATM withdrawals from this account.
This account can save you money without restricting access to your funds. But you must understand the product (repeat: it's a loan). And you must understand yourself. Otherwise, this is not the product for you.
Know Your Limits (or Lack Thereof)
First of all, you don't have to use a mortgage savings account to pay off your mortgage early. And if you have a low fixed rate mortgage you might not want to replace it with a variable loan. Many people achieve a similar end by paying their mortgage bi-weekly, or paying funds into an investment account and using that to retire the mortgage when they are ready. This product merely formalizes your intent to pay this loan as quickly as possible.
In order for this product to work for you, a couple major conditions should be met. One, you need to have a steady paycheck. Because these loans carry variable interest rates, the rates can go up, so you should be reducing the balance ASAP to take full advantage.
Two, you need to be able to control your spending. If you're spending a ton of money from this account, it's going to increase your loan balance, defeating the whole purpose.
Understand What You're Getting Into
With all the current financial mess created at least in part by complex home loan arrangements, it's well past time for people to understand their mortgages rates, the terms, and the underlying concepts. A mortgage savings account is appropriate for certain people. Namely, people who understand the product and have their spending under control.
Bigdy, Carolyn. "New Mortgages: 'Off-Set' Loans." Money Magazine. November 29, 2007.