Complicated Deals Can Distract You From What Is Important

January 8, 2001, Revised January 18, 2011

When I read this article 10 years after I had written it, my impulse was to delete it because the numbers were so out-of-date, but then I realized that it made an important point that I don't believe appears in any of my other articles: making a deal complicated is another technique for exploiting borrowers. The deal described was a loser big time for the borrower, who thought that he had a winner.

"We just refinanced our 1st mortgage for \$138,393 at 8%, our 2nd for \$37,987 at 12%, and one credit card for \$7,438 at 10%, into a new simple interest 1st mortgage at 10.14%/10.52%APR. It is a biweekly that will be paid off in 19 yrs 8.4 months without making additional principal payments. How much better is the simple interest loan?"

You are asking the wrong question at the wrong time. You should be asking whether to do this deal, and you should have asked it before the deal was done.

You paid at least \$6,000 out of pocket for the privilege of converting three separate debts with an average rate of 8.91% into a single debt at 10.14%. That is a loser big-time. The present value of all the additional interest you are going to pay over the next 19 years 8.4 months is greater than \$20,000 – a stiff price for having to write only one check instead of 3.

I can’t be sure what you were thinking because you haven’t replied to my question, but I can make some guesses based on what other borrowers in similar situations have told me. Guess one is that you were focusing too hard on the monthly payment. The new payment is a little lower than the sum of the three old ones, despite the higher rate, because the new mortgage has a longer term. But the higher rate and longer term mean a much slower pay down of the loan balance.

My second guess is that you were distracted by two gimmicky features of the new loan: biweekly payments and simple interest. These features added no value to your new loan, but they may well have distracted you from what was important: the high interest rate.

Biweeklies pay down the loan balance faster, but only because you are making an additional monthly payment every year. Paying half the monthly payment every two weeks means that you are making 13 monthly payments a year instead of 12.
You could have done that, or something equivalent, with your old mortgage. For example, increasing every payment by 1/12 of the payment (for example, a \$600 payment becomes \$650) accelerates the reduction in loan balance in much the same way as a biweekly. See Can I Do My Own Biweekly? I have railed against biweeklies in the past because so many consumers are conned into believing that they must pay for something that they can do for themselves.

Simple interest on top of a biweekly advances the balance pay-down by a small amount because the biweekly payment is credited every 2 weeks rather than at month-end, but because simple interest mortgagers accrue interest daily, you only have to be late on your payment by a few days to lose all the benefit. Read Simple Interest Mortgages: A Trap For the Unwary and Is the Simple Interest Biweekly Mortgage a Scam?

In your case, it appears as if the biweekly/simple interest combination was used to distract your attention from the really important part of the transaction – the increase in your interest rate.

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