Sunday, September 30, 2012

Mortgage Cash Account, An Amazing Tool

A few days ago I said I would go into detail about what a Mortgage Cash Account is. This tool has really been around for some time now, and I think it is one of the best passive saving tools that exist to the average Canadian. My opinion is that it completely changes personal fund allocation rules

Mortgage Cash Account, or MCA, is a liquid and easily accessible virtual (I will explain this term later) account. The term MCA is the one used by Bank of Montreal. It likely exists at other banks as well, but may be called a different name, so don't worry if you haven't heard of it before!




BMO Mortgage Cash Account
At Bank of Montreal, once you have a standard mortgage, you automatically have an MCA. Initially, when your mortgage is first opened, the balance in your MCA is zero (0). Funds get 'deposited' to your MCA whenever you go above and beyond your mortgage payment plan, and pay additional to your regular amortized payments. This is an important point to understand, because it carries multiple meanings.

1. It means your MCA represents money you've put towards accelerating your mortgage payments. This means any additional payments or additional principal payments contribute to your MCA. For example, BMO calculates my repayment plan based on semi-monthly payments, but I actually chose a bi-weekly plan to match up with my pay schedule. This means every year I am making 2 additional payments (52 weeks + bi-weekly = 26 payments vs 24 semi-monthly payments) into my MCA.

2. It means your MCA isn't a physical account in the sense that there is no separate account number associated with it. It is simply a virtual account that keeps track of how much you've overpaid (based on original amortization plan) your mortgage.

Here comes the fun part.

How to Use It
Funds in your MCA are accessible on very short notice (1 business day) and can be completely withdrawn, or re-borrowed by you, at the same rate as your mortgage! The funds are simply added back to your mortgage principal.

When I first heard this, I thought there was some caveat, but other than a quick employment check, there really isn't anything major.

Now that I've explained what it is, and how it works, I think it should be quite clear how this is one of the best savings tools available to Canadians. Let me elaborate. It's really quite simple

1. Whenever you have money you'd like to save, simply make an accelerated mortgage principal payment.

2. When the time comes and you need the money, simply drop in the bank a couple days ahead of time, and make a request to withdraw funds from the MCA.

What? I Thought You Said Savings, Where Is My Interest??
You're probably wondering, how does this equate to a savings account? I don't even earn any interest!

Except you sort of are! Let's take a look at an example.

Let's assume that you have a mortgage of $300k, are paying an interest rate of 3% on that mortgage, and do so bi-weekly. We know that if you make an accelerated principal payment, that comes directly off your mortgage top line when the bank calculates future interest payments. So if you make a payment of $2000 your mortgage is now $298k.

Your bi-weekly payments before the principal payment would contain roughly $346.15 of interest (300k * 0.03 / 26 is a good estimate). After the principal payment, the interest will only make up $343.85 (298k * 0.03 / 26).

By putting that $2000 in, you've saved $2.30 every 2 weeks, or $59.80 over the year, which is approximately what you'd earn if you had put the $2000 in an interest bearing account earning 3% interest.

Now Go Use It!
I'll leave the number crunching to you, but some straight forward math can lead you to the conclusion that if you put the money towards your mortgage principal when you have it, and take it back out from your MCA when you need it (say for a car or some new appliances), the amount of mortgage interest saved is exactly the same as the interest earned if you had put that money in an interest bearing savings account. It becomes even more attractive when you consider that interest earned from a savings account is subject to taxation at your marginal income tax rate, AND that there aren't even really any options to earn more than 1-2% interest these days, unless you lock in for long periods of time. All these things combined make it attractive for even a rainy day fund to sit inside your MCA.

 This is why I believe the MCA is one of the best savings tools available to Canadians, and every person with a mortgage should fully utilize it!

24 comments:

  1. Are you sure that the interest rate you pay on money re-borrowed from the MCA is the same as your mortgage? I have heard conflicting info that suggest the rate is a "blended" rate between your mortgage rate and the current bank rate. Hoping you can tell me for sure if you have actually withdrawn from your MCA.

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  2. thanks for reading! i can confirm i drew from my MCA last year and the bank person said it will be the same rate as my current mortgage rate. if i look online i can also see that just the mortgage amount went up, nothing else changed, rate is still 2.25%

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  3. Mortgages all have a term representing the length of time before your home is paid off and a rate which determines the principal and interest payment that will be required to be paid during this term.

    mortgage loan

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    Replies
    1. to be clear, interest rate is strictly determined by mortgage amount and rate. amortization period has no direct effect on how much interest you owe per year. amortization period affects how much mortgage principal you are required to pay off each time (such that by the end of amortization period, your principal = 0. lengthening it does result in more interest paid over time (from slower reduction of principal). the simplest way to prove this is comparing a 25 yr amortization vs 35 year + extra payments. if you take the lower monthly payments on the 35 year, but pay the monthly savings from going from 25 to 35 amortization, in the form of accelerated principal payments, you arrive at the same result, but have more flexibility.

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  9. Thanks for the clear explanation. Saves me a trip to my local branch.

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  18. Indeed... I'm (hopefully) not looking to ever withdraw from the MCA but I just recently changed up my mortgage from monthly to accelerated bi-weekly and increased the payment by its maximum available by my terms (20%) and I knocked fully 10 years off the payments. I'm saving over $32,000 in interest!

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  19. but all of the money is not disbursed at one time. The lender will make further advances of credit in the future. mortgage broker toronto

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  20. Assuming you did not withdraw any funds from you mortgage cash account what would cause the mca balance to be reduced from one year to another. NB paying mortgage monthly

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