As I sit here listing to my “Closing Time (by Semisonic)”
radio station on Pandora – and all its iterative loops of similarly-styled
music in the Pandora algorithm – trying to hear the actual song “Closing Time”
as frequently as possible, it reminds me a series of commercials I often
hear on traditional radio stations each day. First, let me caveat the
commercial by stating that I listen to exclusively talk radio. I literally
don’t ever listen to music-based radio in the car and couldn’t even tell you a
station that plays music in the central Indiana area. So if you’ve not heard
these commercials, trust me, they’re played several times on every single break
on my stations.
The advertisement to which I refer above is one
perpetuated by seemingly every retail bank that does business with consumers in
the Midwest – each is relatively the same, stating something like “Choose us
for your mortgages and loans because we allow you to skip two payments. Aren’t
we so connected to and caring for our customers?” Now, I can’t verify this is
the exact phrasing used in each ad, but it’s always something similar. “So?”,
you ask, “Why isn’t this a good thing? I like to skip payments!” Good question.
You see, as I sit here listening to the song “Closing Time”, it reminds me of
one of my only jobs where I ever actually worked until the closing time – at a
very reputable , good, conservative Indiana bank. At this bank, we featured a
very similar service, and having just completed my first ever finance and
time-value of money course when I worked there, I spent some time one day
considering the impact on consumers.
Since this banking trend is now becoming grossly popular,
let me spend a little here explaining my findings and why you, at ALL costs,
should avoid this “friendly” practice of “skipping” mortgage payments. In order to do this, let me present a
specific scenario that gives you an overall idea of the costs of engaging in
the mortgage-skipping process.
In my scenario, the customer is a relatively new
homebuyer or someone who relatively recently re-mortgaged. Let’s say this
homebuyer conformed to the following constraints in the scenario:
Purchase Price
- $150,000 (the average home purchase price for a home in the Midwest)
Mortgage Loan
Value - $120,000 (assuming the person followed the convention of putting
20% down payment)
Loan Terms –
30 years at 5.5% (I think these are reasonable terms for a home buyer today)
Skipped Loans
– After 4 years (This is a fairly new home owner and he wants to skip two
payments after 4 years of making his monthly payments)
In this scenario, the dollar cost of
skipping the two payments after 4 years is $5,128! That means, over the
course of the entire mortgage, it will cost the buyer an addition $5,128 over
what it would have been initially. Instead of paying $245,284.84 for the
$120,000 loan (because of interest and amortization), it will cost $250,412. I
don’t know about you, but for me, skipping the $681 monthly payments for two
months is not worth the extra $5,128.
The worst part about this entire process is that many of
the advertisements inform the consumer that the loan payment may actually
decrease after the skipped payments, which is extraordinarily deceptive.
Although the bank may actually decrease the monthly payments it’ll be
marginally less and will simply eat a little into that additional $5,128 paid.
For example, if the monthly payments began at $681 and are decreased to $671,
that will decrease the additional $5,128 down to about $2000 extra paid. So
even though it seems as though the consumer is paying less, the extended terms
of the loan position it such that the bank earns an extra $2,000 over the
course of the loan.
None of this, however, is to advocate for abolishing this
kind of practice. I fully acknowledge that, to some people, it’s more
beneficial to skip a couple payments now for more prioritized matters, and
paying the additional money over the course of the loan is acceptable because
of the time-sensitive nature of the reason why the payments are skipped.
However the majority of the individuals who select to skip payments do so
because they don’t understand the full implications of the decision. They
operate under the assumption that the bank is simply being nice and the loan is
being placed “on hold” for the two months. While that may be true in some
circumstances, in most, the principle of the loan is still accruing interest
and the consumer is expected to pay that interest at an amortized rate.
So, my friends, be careful when considering if YOU are
going to skip your mortgage. Make sure to ask for a complete adjusted mortgage
schedule and calculate the difference out yourself.
