First some background and then my standard explanation of SmartEquity (Money Merge Accounts). Although not new, money merge accounts (also known as Australian Mortgages) are new to the Canadian market. It's estimated at 35% of Australians and British mortgagee's use a Mortgage Acceleration program. Like the 15 year mortgage and the bi-weekly payment program, Money Merge Accounts pay down principal on the primary mortgage more quickly than a traditional 30 year mortgage. They just do it differently. In order for Mortgage Acceleration programs work you must spend less than you make which is known as disposable income.
Money Merge Accounts use the benefits of an open-ended mortgage to cancel interest, thereby paying down principal faster. To use a money merge account, requires a fundamental shift in the way we manage money as follows:
Assumptions: $300,000 Mortgage, $5,000 monthly net income, paid biweekly at $2,500 each paycheck. Unspent income of $500.00 per month.
1. For the money merge account to work, you must have access to an open ended line of credit know as an ALOC or HELOC (Home Equity Line of Credit). Unlike closed ended mortgages, ALOC are open ended meaning that any money that goes into these accounts, pays down Principal and cancels interest. This is distinctly different from a closed end mortgage where payments are made to interest first and principal last.
2. The ALOC or HELOC is used as your primary checking account. To take full advantage of the line of credit, each month when you get paid, deposit your paycheck directly into the checking account/line of credit (HELOC)
3. Lets' assume that you have no debt, just your house payment. You get a line of credit using the equity in your home. At the start of the HELOC, you make a principal mortgage transfer of $5,000 from the HELOC to your primary mortgage. The principal on the primary mortgage is now $295,000 and the HELOC has a balance of $5,000 for a total of $300,000. This single transfer of $5,000 shave 1.5 years off the repayment period for the primary mortgage.
4. Deposit your $2,500 paycheck into the HELOC, which you use as a checking account. This paycheck immediately lowers the Principal balance of the HELOC to $2,500, thereby cancelling interest on 1/2 of the original $5,000 balance. Pay your bills, buy groceries etc from the HELOC. The HELOC balance will climb until you get paid again 2 weeks later when the next $2,500 paycheck is deposited, again lowering the balance on the open ended line of credit and cancelling interest. As long as you keep spending less than you make, the disposable income will continue to cancel and pay down the principal balance of the HELOC.
5. As the principal balance on the HELOC gets paid down, periodic principal transfers take place from the HELOC to the primary mortgage, thus lowering the balance of the principal mortgage more quickly and canceling interest overall.
Benefits: Interest is canceled and as equity grows on the principal balance of the mortgage, it's possible to increase the line of credit. This allows the consumer to have quick access to cash for other investments or life expenses. Much more control over your financial future and the ability to use the equity in the home for other financial and investment opportunities.
Cons: If you are inclined to spend more than you make or do a great deal of impulse shopping, you may want to rethink this strategy. HELOCs have variable rate of interest. If used as designed this interest is irrelevant, however if income decreases or disposable income decreases, the higher interest can become a factor.