(Mon Dec 15th, 2008

I'll continue my discussion about credit card arbitrage. While it is not a trading strategy per se, it does create several options for low risk investing. In the Credit Card Arbitrage article I discussed the typical credit card arbitrage strategy. In this post I'll talk about a different arbitrage strategy that might be of interest to the more risk averse.

Pre-pay Mortgage Arbitrage

There is no common name for this investment idea, so I'll call it Pre-pay Mortgage Arbitrage. In this scenario, you are already planning on paying $500 extra towards your 8% mortgage every month for one year and you know, with reasonable certainty, that you will have this money.

In Pre-pay Mortgage Arbitrage instead of paying your mortgage down each month for a year, you would take out a low rate credit card offer for $6000 (12 multiplied by $500) and pay that as extra towards your mortgage principal immediately. You then pay off the credit card in the 12 monthly installments you had already planned on paying towards your mortgage.

Here is how the three mortgage payment scenarios differ for a $250,000 30-year 8% mortgage.

No prepayment.

Total interest paid over life of mortgage -- $410,388.12

Principal balance at end of first 12 months -- $247,911.59

Life of the loan -- 360 months

Standard $500/month prepayment for 12 months.

Total interest paid over life of mortgage -- $359,587.12

Principal balance at end of first 12 months -- $241,686.63

Life of the loan -- 330 months

$6000 Pre-pay Mortgage Arbitrage

Total interest paid over life of mortgage -- $357,696.56

Principal balance at end of first 12 months -- $241,456.63

Transfer fee on the $6000 0% credit card loan -- $180

Life of the loan -- 329 months

Payment to Credit Card -- $525 / month for 12 months

Notice that with either mortgage pre-payment the total interest paid on the loan is greatly reduced. But what the critical eye can see is that the Pre-pay Mortgage Arbitrage strategy lowers the total interest paid by an additional $1890.56. When you factor in the $180 transfer fee the savings equals $1710.56.

If you used the Pre-pay Mortgage Arbitrage strategy every year for the life of the loan rather than pre-paying $500 a month for the life of the loan the loans look like this:

Standard $500/month prepayment

Total interest paid over life of mortgage -- $189,726

Life of the mortgage -- 189 months

Pre-pay Mortgage Arbitrage:

Total interest paid over life of mortgage -- $182,879

Life of the mortgage -- 184 months

The additional savings equal $4087($6,847 minus $2760 in transfer fees) vs the standard prepayment.

Now I'm not advising anyone to use this strategy but what I can say is that if I was already prepaying my mortgage and I knew that I had the money I wouldn't pass up the opportunity to save an extra $1710.56 for a one year prepayment or an extra $4,087 for the life of the loan.

If you look at each year separately the Pre-pay Mortgage Arbitrage: strategy (assuming the same loans as above) would only save you about $50 as reflected in the year end mortgage balances compared with the standard prepay example above. The real savings come from the total interest paid and reduced loan life, not from the year to year balance difference.

Pre-pay Mortgage Arbitrage example overview

Standard Pre-pay Mortgage example overview

For $150 I can crunch the numbers for you and see whether or not you would be able to save any money using this method. You'll need to know your mortgage rate and have a low interest rate card offer in hand for me to do the math. Use the contact form on our Contact page to contact me. I won't advise you on what to do, I'll just run the numbers and let you decide what is best.

This site is for educational purposes only. I am not a broker, investment advisor, accountant, or lawyer. This site is use at your own risk!