posted: Dec. 12, 2001 @ 10:37a
First off, credit goes to dukee for doing the initial legwork on this somewhat unusual "increment" method of computing HEL terms at netbank (versus more common "invoice" method, distinction credited to ridin4free). He has been proven 100% correct.
As dukee first indicated in the main Netbank/First HEL thread at http://www.fatwallet.com/forums/messageview.cfm?start=0&catid=18&threadid=53218 , netbank's HEL is computed as what they call a "Simple Interest Loan" using an "increment" billing method rather than a conventional HEL or mortgage loan, which uses an invoice method using compounding interest. That means that a conventional amortization table that is used to calculate other loans is inapplicable in this case. Instead, when you make a payment, the payment is applied on the day check reaches them. Simple interest accrued since the last payment was received is then deducted, and any remainder is applied to principal. So the formula is:
(Principal balance) x (loan rate)/365 x (days from last payment) = portion of current payment devoted to interest
Here is the exact text taken from the Netbank promissory note:
I will pay this loan in 180 payments of $795.44 each. My first payment is due Dec 2 2001, and all subsequent payments are due on the same day of each month after that. My final payment will be due Nov 2 2016 and will be for all principal, all accrued interest and all other unpaid costs and charges not yet paid. Payments include principal and interest. Unless otherwise agreed to or required by applicable law, payments will be applied first to accrued unpaid interest, then to late charges, then to fees and then to principal. Interest on this note is computed on a 365/365 simple interest basis: that is, by applying the ratio of the annual interest rate over the number of days in a year (266 during leap years), multiplied by the outstanding principle balance, multipled by the actual number of days the principal balance is outstanding.
(Disclaimer: this is followed by a "prepayment" section, which says that if I elect to prepay, there (1) is no penalty to prepay, and (2) no obligation on netbank's part to relieve me of monthly payments unless I get it from them in writing. That does suggest that if my early payments would have been coded as prepayments, rather than regular payments, I would have needed written approval to make this all work. Happily, this did not prove to be the case with Netbank.)
This effectively means that ANY pre or over-payment you make to netbank is a de facto prepayment of principle, EVEN THOUGH every monthly payment still pushes back the time of your next payment due by an entire month. This makes exact balance figures difficult to calculate at any given time, but that trivial disadvantage is offset by a major advantage: you can strategically pay off the loan to maximize mortgage interest tax deductions and interest rate fluctuations in the market without giving ANY tax free loan to Netbank (as you would using these strategies with a conventional mortgage.) Let me use my situation as an example.
Generally, my wife and I (32 and 31, dual income, no kids) face a close call between choosing to itemize and choosing to take the standard deduction on our taxes. (Recall that mortgage interest, along with most other potential deductions including charitable deductions, are deductible ONLY if you itemize.) For reference, here are the standard deductions for 2001:
Married filing jointly/Qualifying widow(er) $7,600
Married filing separately $3,800
Head of household $6,650
This year, it will make sense to itemize, thanks to significant charitable deductions and $7K+ in mortgage interest (but not much else.) However, thanks to netbank, our mortgage interest next year will drop to around $5400 or so, keeping us well below the standard deduction cutoff line (which will be adjusted upward for inflation next year anyway.) So it will only be thousands in charitable contributions that will allow us to break even.
So, here's the strategy. We're going to pay ALL the rest of our 2002 netbank payments (Feb-Dec)--about $8800 at the end of Dec 2001. (Note that part of the Feb payment will be interest, based on the above forumula, while ALL of EVERY OTHER payment will go straight to principle, cutting our balance and interest accruing, and thereby reducing the life of the loan.) Then we pay NOTHING at all on our netbank loan in 2002. We also wait until Jan 1 2003 to make our Christmas 2002 charitable contributions. As a result, we have NO deductable interest or charitable contributions in 2002, and we take the standardized deduction.
THEN, in 2003 we resume regular netbank payments. Because we will have accumulated $4725 in 2002 back interest, essentially ALL of the 2003 payments we make--$9600 or so--will go to interest, and be fully deductable. When we add 2002 (done in Jan 2003) AND 2003 (done in Dec 2003) charitable contributions, we will have itemizable deductions that dwarf the standard deduction, and come out way ahead by itemizing. We can then repeat the cycle, taking the standard deduction in 2004, and the big writeoff in 2005. This should save us $1-3 thousand in taxes in every odd-numbered year for the next several years.
BUT WAIT, THERE'S MORE:
By making the big payoff now, we (and you!) can take advantage of VERY low interest rates. To wit, the prime is now 4.75%, and many credit cards are offering 0% for nine months or more, 1.9% for a year, etc. And, by drawing on credit lines like this (or simply investing your "extra" from netbank or savings), you get an effective 5.25% sure thing on your "investment" in prepaying your netbank HEL by say 11 payments. So, assuming you have this $ available at these low rates, YOU MAKE A PROFIT doing this even aside from the tax benefits. And if you would not have itemized your deductions for 2002 anyway, all those "profits" would effectively be tax free <img src="i/expressions/face-icon-small-smile.gif"border=0>
By paying off a chunk now per the above strategy, in a couple of months your credit reports will show you owe that much less on your house (e.g., $89K versus $100K.) That means that if you want to open a second HEL or HELOC with someone else, you'll be more capable of doing so, because the Loan-to-Value on your house will show up as less. So, you can do this with a 6 month credit card balance transfer offer, then wait 3 months, get a DeepGreen Bank HELOC for a HIGHER amount than you could otherwise, and then use the extra part of that HELOC to pay off the balance transfer after the promo period is over (or as a source of reserve funds should you need it.)
NOTE THAT MONLTY PAYMENT AMOUNT NEVER CHANGES.
No matter what, your due monthly payment is fixed for the life of the loan. Paying extra just means you shave months off the term of the loan. This is like most conventional fixed rate mortgages, but unlike conventional adjustable rate mortgages, where the monthly payment is generally recomputed every year.
SOME OTHER IMPLICATIONS:
-Don't be afraid to send in your payment coupons early. It will only help you by acting as an immediate, hassle-free prepayment to principle.
-In tax years where you intend to itemize your deductions (which allows you to deduct mortgage interest), make your last payment for that year as close to Dec 31 as possible without being later than that. This way, you'll have the maximum possible interest deducted in that calandar year.
-Never mark a netbank payment as "additional payment to principle." Just pay future month's payment coupons early. Why do this when paying off extra months early has the same effect, AND effectively lets you skip payments later with no penalty?
Is all this clear?
Do any of you have other related ideas?
What did I miss?
UPDATE 5/8/02: I've posted a new webpage herethat should clarify my current thinking on this. I will be discussing its implications for all increment, simple interest loans in its own thread, but thought it might be helpful to add it here.
UPDATE 01/07/03: It officially worked! As of this morning, netbank has recorded my 12 payments for 2003 AND credited all the interest accrued in 2002 to 2003, as hoped. The web page has been updated accordingly.