Please explain "pocket-change prepayments" on a mortgage
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Please explain "pocket-change prepayments" on a mortgage
Hello. I'm reading Anthony Robbins' book: Money: Master The Game.
In his section about mortgages, he says that interest on a mortgage will actually tack on 100% or more to a loan! So a $1M house, you would pay $2M over the 30-year period. Crazy.
He has a solution. He calls it "pocket-change prepayments."
"Cut your mortgage payments in half! The next time you write your monthly mortgage check, write a second check for the principle-only portion of next month's payment."
He goes on to explain that it's money you'll have to pay anyway the following month, but if you pay it a couple of weeks early, you'll enjoy savings down the road. On a 30-year loan for $270k at 6%, you would pay $1,618 monthly. But with this technique, you would write a second check of $270, next month's principle balance. And you would never pay interest on this. AND cut your 30-year mortgage in half. Paid off in 15 years.
Can someone explain this to me a little better?
In his section about mortgages, he says that interest on a mortgage will actually tack on 100% or more to a loan! So a $1M house, you would pay $2M over the 30-year period. Crazy.
He has a solution. He calls it "pocket-change prepayments."
"Cut your mortgage payments in half! The next time you write your monthly mortgage check, write a second check for the principle-only portion of next month's payment."
He goes on to explain that it's money you'll have to pay anyway the following month, but if you pay it a couple of weeks early, you'll enjoy savings down the road. On a 30-year loan for $270k at 6%, you would pay $1,618 monthly. But with this technique, you would write a second check of $270, next month's principle balance. And you would never pay interest on this. AND cut your 30-year mortgage in half. Paid off in 15 years.
Can someone explain this to me a little better?
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Re: Please explain "pocket-change prepayments" on a mortgage
You are paying 1 1/2 times, yes it will cut down the years of payment.
Make sure, you are paying additional payment and not just two checks for the same mortgage amount.
If you payment is $1000, your first check is $1000 and your second check is for $500.
I do not think the mortgage company will accept two $500 checks, when your interest itself is $750 or so
Make sure, you are paying additional payment and not just two checks for the same mortgage amount.
If you payment is $1000, your first check is $1000 and your second check is for $500.
I do not think the mortgage company will accept two $500 checks, when your interest itself is $750 or so
Invest when you have the money, sell when you need the money, for real life expenses...
Re: Please explain "pocket-change prepayments" on a mortgage
Robbins apparently carries around a bit more pocket change than I do. Granted, I'm not worth 480 Million either.
Re: Please explain "pocket-change prepayments" on a mortgage
neomutiny06,neomutiny06 wrote:Hello. I'm reading Anthony Robbins' book: Money: Master The Game.
In his section about mortgages, he says that interest on a mortgage will actually tack on 100% or more to a loan! So a $1M house, you would pay $2M over the 30-year period. Crazy.
He has a solution. He calls it "pocket-change prepayments."
"Cut your mortgage payments in half! The next time you write your monthly mortgage check, writes a second check for the principle-only portion of next month's payment."
He goes on to explain that it's money you'll have to pay anyway the following month, but if you pay it a couple of weeks early, you'll enjoy savings down the road. On a 30-year loan for $270k at 6%, you would pay $1,618 monthly. But with this technique, you would write a second check of $270, next month's principle balance. And you would never pay interest on this. AND cut your 30-year mortgage in half. Paid off in 15 years.
Can someone explain this to me a little better?
If a person is in a high tax bracket and has not maxed up their Trad. 401K contribution, it may not be a good idea. For example, if a person is in the 25% tax bracket, the person is paying 25% tax for every dollar used to pre-pay the mortgage.
Know how to calculate. Then, you can make your own assessment.
KlangFool
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Re: Please explain "pocket-change prepayments" on a mortgage
Robbins is lying with math (or you're reading a really old book).neomutiny06 wrote:Hello. I'm reading Anthony Robbins' book: Money: Master The Game.
In his section about mortgages, he says that interest on a mortgage will actually tack on 100% or more to a loan! So a $1M house, you would pay $2M over the 30-year period. Crazy.
While it is true that at 5.3% real interest, you pay almost double the borrowed amount's worth of buying power in interest, this has nothing to do with the current reality.
Top tier mortgages today are available at < 4% (nominal) and offset by a roughly 2% annual inflation target and perhaps another 1% of tax savings - compared to Robbins' 5.3% real interest rate example, today's borrower is paying less than 2% real. Doing the math at 2% real, the cost of the mortgage paid over 30 years is at worst 33% of the buying power of the original loan. If inflation grows at more than 2%, it is possible the real cost of the loan will be negative over the 30 years.
Prepaying small amounts will reduce the amount paid in interest and shorten the term of the loan, however impact on your buying power is much less than Robbins shows by ignoring inflation. Potentially worse, this ties up your money until the end of the loan / you sell your house.
If you are someone who will otherwise squander the money, or who has an absurdly high mortgage rate, prepayment will lead to a better financial outcome over time.
If your mortgage rate is close to (or below) inflation after taxes, there may be little or negative benefit to prepayment vs. saving separately and paying off the entire loan when you can.
Re: Please explain "pocket-change prepayments" on a mortgage
I wouldn't and have never heard it called pocket-change prepayments. I don't consider $270 (in your example) pocket change.
But, yes, double-principal payments are a long-standing strategy to cut your mortgage term in half. But the extra double-principal amount does escalate over time. I have my mortgage amortization table set up to start double principal payments next January. (At that point, I estimate that we'll have sufficient emergency funds in taxable that I would rather prepay the mortgage than accumulate more in instruments yielding less than our 3.74% mortgage costs us.)
Our January 2017 payment will be $1,826.70 ($309.45 interest, $565.08 principal, $387.09 escrow, $565.08 principal).
January 2018 would be $1871.74 with an extra $610.12.
January 2019 would be $1,920.20 with an extra $658.66.
January 2020 would be $1,972.57 with an extra $710.95.
January 2021 would be $2,028.88 with an extra $767.26.
January 2022 would be $2,089.59 with an extra $827.97.
The highest payment would be August 2022 at $2,127.14 with an extra $865.62.
A partial payment in September 2022 would pay it off.
The loan is set to be paid off in May 2028 with flat payments of $1,261. (It varies slightly each year based on escrow calculations.)
You could also calculate a flat amortization with a payoff in September 2022, but if you expect your income to continue to grow, the double-principal payment is a common alternative.
But, yes, double-principal payments are a long-standing strategy to cut your mortgage term in half. But the extra double-principal amount does escalate over time. I have my mortgage amortization table set up to start double principal payments next January. (At that point, I estimate that we'll have sufficient emergency funds in taxable that I would rather prepay the mortgage than accumulate more in instruments yielding less than our 3.74% mortgage costs us.)
Our January 2017 payment will be $1,826.70 ($309.45 interest, $565.08 principal, $387.09 escrow, $565.08 principal).
January 2018 would be $1871.74 with an extra $610.12.
January 2019 would be $1,920.20 with an extra $658.66.
January 2020 would be $1,972.57 with an extra $710.95.
January 2021 would be $2,028.88 with an extra $767.26.
January 2022 would be $2,089.59 with an extra $827.97.
The highest payment would be August 2022 at $2,127.14 with an extra $865.62.
A partial payment in September 2022 would pay it off.
The loan is set to be paid off in May 2028 with flat payments of $1,261. (It varies slightly each year based on escrow calculations.)
You could also calculate a flat amortization with a payoff in September 2022, but if you expect your income to continue to grow, the double-principal payment is a common alternative.
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Re: Please explain "pocket-change prepayments" on a mortgage
Personally, I like Prof. Guttentag's explanations. Prof. Guttentag, a.k.a. "The Mortgage Professor", is one of the few people who explain the subject both clearly and intelligently. Just recently, he published a four-part series on mortgage repayments, which can be found here:http://www.mtgprofessor.com/ . Just scroll down and you will find it. I also suggest that you use one of of his calculators on mortgage prepayments. It's on his web site. I believe the relevant calculator is 2a. You can play with the calculator. One hypothetitical loan repayment schedule is worth a thousand words.
"'Thoughts without content are empty, intuitions without concepts are blind." Immanuel Kant
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Re: Please explain "pocket-change prepayments" on a mortgage
If you plan to regularly prepay a mortgage by that large of an amount, you might as well get a 15-year loan and enjoy a lower interest rate.
Re: Please explain "pocket-change prepayments" on a mortgage
On a 30-year amortization schedule, the principal portion of each payment during the first few years will be nominal. As noted above, if you strictly adhere to doubling the amount that is going toward principal, your required payment each month will increase.
In my experience, it was easier to just determine the amount of excess cash flow I wanted to apply to my mortgage and add that to my monthly payments. Allows for a flat payment vs. monthly calculations, and much easier to forecast effects on the loan's maturity.
In my experience, it was easier to just determine the amount of excess cash flow I wanted to apply to my mortgage and add that to my monthly payments. Allows for a flat payment vs. monthly calculations, and much easier to forecast effects on the loan's maturity.
Re: Please explain "pocket-change prepayments" on a mortgage
For all 3 mortgages I've had in my life (all 30 year), I added enough extra to the first payment to make sure 50% of the check was applied to principal (excluding the escrow amount). Then I kept that payment fixed moving forward.
Seemed like a good idea to throw a little something extra on it. Not a whole lot of optimization analysis. I'll reassess at a later date.
Seemed like a good idea to throw a little something extra on it. Not a whole lot of optimization analysis. I'll reassess at a later date.
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Re: Please explain "pocket-change prepayments" on a mortgage
If that's money you would have otherwise invested in your retirement portfolio, you may become poorer over time.
If that's money you would have used to buy something that made you happy, you may become sadder over time.
If that's money you would have used to build up an emergency fund instead, you may become less resilient over time.
Whether the strategy makes sense for you depends on your circumstances. It is normally pitched as a way to trick you into doing a good thing instead of the bad thing you'd do otherwise. But if you aren't prone to doing the bad thing the trick may do more harm than good. And if you are doing something bad there may be other options for getting on track.
If that's money you would have used to buy something that made you happy, you may become sadder over time.
If that's money you would have used to build up an emergency fund instead, you may become less resilient over time.
Whether the strategy makes sense for you depends on your circumstances. It is normally pitched as a way to trick you into doing a good thing instead of the bad thing you'd do otherwise. But if you aren't prone to doing the bad thing the trick may do more harm than good. And if you are doing something bad there may be other options for getting on track.
Re: Please explain "pocket-change prepayments" on a mortgage
Unless you can "re-cast", your mortgage payment will continue. True, the interest portion will decrease and the principal increase, but the monthly payment will remain the same. We ran this by our lender, and got "nice try, no cigar".
Re: Please explain "pocket-change prepayments" on a mortgage
Only interest is an expense. Principal payments are not an expense. Paying extra principal does not change your net worth, only reduces future interest expense.
Mortgage "Pocket-Change Prepayments"
.
I do not consider $250 pocket change either nor do I even consider $10 pocket change, but some people might consider $10 pocket change and back in the 1980's the principal-only portion of the next month's payment on our 30 year mortgage was around $10 during the early months of our mortgage. Paying ahead a month or two of extra principal helped to reduce the long term interest costs of a 30 year mortgage.
I do not consider $250 pocket change either nor do I even consider $10 pocket change, but some people might consider $10 pocket change and back in the 1980's the principal-only portion of the next month's payment on our 30 year mortgage was around $10 during the early months of our mortgage. Paying ahead a month or two of extra principal helped to reduce the long term interest costs of a 30 year mortgage.
jhfenton wrote:I wouldn't and have never heard it called pocket-change prepayments. I don't consider $270 (in your example) pocket change.
Randy |
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Re: Please explain "pocket-change prepayments" on a mortgage
I don't understand this comment. If you pay off your mortgage (principal = $0) in half the stated term, the payments do cease at that point. Paying ahead doesn't allow you to skip payments at any point prior to the payoff, but I don't think anyone claimed that.john94549 wrote:Unless you can "re-cast", your mortgage payment will continue. True, the interest portion will decrease and the principal increase, but the monthly payment will remain the same. We ran this by our lender, and got "nice try, no cigar".
Re: Please explain "pocket-change prepayments" on a mortgage
We thought about paying down some, but not all, of our mortgage. Simply stated, the bank advised our monthly payment would click along as per usual. They could not "re-cast" the mortgage, as it were. They could "re-finance" it (which we did not want).jhfenton wrote:I don't understand this comment. If you pay off your mortgage (principal = $0) in half the stated term, the payments do cease at that point. Paying ahead doesn't allow you to skip payments at any point prior to the payoff, but I don't think anyone claimed that.john94549 wrote:Unless you can "re-cast", your mortgage payment will continue. True, the interest portion will decrease and the principal increase, but the monthly payment will remain the same. We ran this by our lender, and got "nice try, no cigar".
Re: Please explain "pocket-change prepayments" on a mortgage
The effect is more dramatic at higher interest rates. Our first (and only!) mortgage was something like 9%.
Here are the first few payments for a $100K, 9%, 30 yr mortgage, broken down into principal and interest (rounded to nearest dollar):
Payment# Principle Interest
1 55 750
2 55 750
3 55 749
4 56 749
5 56 748
6 57 748
So, if on month 1 you have an extra $110 handy, you send in the normal payment (750+55=805) plus the principle for payments #2 and 3 (55+55=110). That $110 means you have now made payment #2 and 3. You don't get to skip two months, but next month when you send in the $805, you're making payment #4. You never pay the $750 in interest for payment #2 or the $749 for payment #3.
Of course, toward the end of the mortgage, the proportions flip, and it's harder to do. Early on, though, it feels pretty good to get a tax refund or whatever and make 6 months worth of payments.
Plug your numbers into a calculator (like http://www.bankrate.com/calculators/mor ... lator.aspx - 'calculate' and then 'show amortization schedule') and print out the schedule, and have fun every month drawing lines through however many payments you can cross off.
Here are the first few payments for a $100K, 9%, 30 yr mortgage, broken down into principal and interest (rounded to nearest dollar):
Payment# Principle Interest
1 55 750
2 55 750
3 55 749
4 56 749
5 56 748
6 57 748
So, if on month 1 you have an extra $110 handy, you send in the normal payment (750+55=805) plus the principle for payments #2 and 3 (55+55=110). That $110 means you have now made payment #2 and 3. You don't get to skip two months, but next month when you send in the $805, you're making payment #4. You never pay the $750 in interest for payment #2 or the $749 for payment #3.
Of course, toward the end of the mortgage, the proportions flip, and it's harder to do. Early on, though, it feels pretty good to get a tax refund or whatever and make 6 months worth of payments.
Plug your numbers into a calculator (like http://www.bankrate.com/calculators/mor ... lator.aspx - 'calculate' and then 'show amortization schedule') and print out the schedule, and have fun every month drawing lines through however many payments you can cross off.
Re: Please explain "pocket-change prepayments" on a mortgage
+1jalbert wrote:If you plan to regularly prepay a mortgage by that large of an amount, you might as well get a 15-year loan and enjoy a lower interest rate.
Or even with a 30 year mortage make payments as if it was only 15 years.
But that would not sell books.
Re: Please explain "pocket-change prepayments" on a mortgage
I think I would go to Tony if I needed motivation. Not sure about his qualifications for giving financial or investment advice. People who are very good at motivating people, and his is, scare me. They are the type who could easily convince you to do anything-- like buying gold coins or trying the amazing "all natural" chocolate diet.
Nothing wrong with adding additional money to your normal mortgage payment. Actual pocket change won't make much difference - you need to get into your checkbook to make it matter.
Nothing wrong with adding additional money to your normal mortgage payment. Actual pocket change won't make much difference - you need to get into your checkbook to make it matter.
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Re: Please explain "pocket-change prepayments" on a mortgage
So when Tony says "you will never pay interest on this second check you write each month" he's simply teaching you the best method to pay more. There's no secret savings here.Dandy wrote:I think I would go to Tony if I needed motivation. Not sure about his qualifications for giving financial or investment advice. People who are very good at motivating people, and his is, scare me. They are the type who could easily convince you to do anything-- like buying gold coins or trying the amazing "all natural" chocolate diet.
Nothing wrong with adding additional money to your normal mortgage payment. Actual pocket change won't make much difference - you need to get into your checkbook to make it matter.
Re: Please explain "pocket-change prepayments" on a mortgage
The OP didn't ask about tax rates, buying power, inflation, and all the other stuff folks. How about we just answer what they asked for the explanation on?
OP, most mortgages base the interest owed per month on the mortgage balance at the time. The monthly payment amount is fixed from the start. But, the portion paid to principal and interest changes based on the balance owed. If you prepay or pay down the principal ahead of schedule, you change/lower the balance faster than the mortgage had set up. As said, if you pay down the principal by $270 or $1000 or $50k or whatever, you never pay interest on that amount again since you lowered the balance by that much.
The amortization schedule is made when you take out the loan, but you don't have to stick to it. Once you jump ahead on the schedule by lowering the balance, you pay less interest from then on.
OP, most mortgages base the interest owed per month on the mortgage balance at the time. The monthly payment amount is fixed from the start. But, the portion paid to principal and interest changes based on the balance owed. If you prepay or pay down the principal ahead of schedule, you change/lower the balance faster than the mortgage had set up. As said, if you pay down the principal by $270 or $1000 or $50k or whatever, you never pay interest on that amount again since you lowered the balance by that much.
The amortization schedule is made when you take out the loan, but you don't have to stick to it. Once you jump ahead on the schedule by lowering the balance, you pay less interest from then on.
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Re: Please explain "pocket-change prepayments" on a mortgage
Exactly. Seems like he has made an extremely simply concept more complex. I think he is selling it like it is some sort of secret by doing it the harder way.Watty wrote:+1jalbert wrote:If you plan to regularly prepay a mortgage by that large of an amount, you might as well get a 15-year loan and enjoy a lower interest rate.
Or even with a 30 year mortage make payments as if it was only 15 years.
But that would not sell books.
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Re: Please explain "pocket-change prepayments" on a mortgage
But that's what I'm asking. So there is no secret here? He made is sound like if you write 2 checks a month, you avoid tons of interest. And most people don't take advantage.stoptothink wrote:Exactly. Seems like he has made an extremely simply concept more complex. I think he is selling it like it is some sort of secret by doing it the harder way.Watty wrote:+1jalbert wrote:If you plan to regularly prepay a mortgage by that large of an amount, you might as well get a 15-year loan and enjoy a lower interest rate.
Or even with a 30 year mortage make payments as if it was only 15 years.
But that would not sell books.
Re: Please explain "pocket-change prepayments" on a mortgage
Correct, they could save tons of interest by paying ahead.
Correct, most people don't do that because they don't have extra money to throw at the mortgage. Or, they spend it on other things. Then end up paying lots of interest over 30 years.
Correct, most people don't do that because they don't have extra money to throw at the mortgage. Or, they spend it on other things. Then end up paying lots of interest over 30 years.
Re: Please explain "pocket-change prepayments" on a mortgage
I'm not sure what the magic of two checks (or two ACH payments) per month is, either. If I pay extra on my mortgage, it automatically goes to principal.
Re: Please explain "pocket-change prepayments" on a mortgage
Just wanted to point out for the sake of clarity to the OP, you don't have to physically write out 2 separate checks.
If you send in a payment that's higher than the required amount, the additional amount is applied to the principal balance. The accelerated reduction in principal lets you pay less interest over the life of the loan than what is shown on the original amortization schedule and you pay the loan off faster.
In terms of return on your money, think of paying additional to the mortgage as putting that money in a CD paying the same rate as the mortgage's interest rate. Only difference is you can't "redeem" that CD until you sell the property.
If you send in a payment that's higher than the required amount, the additional amount is applied to the principal balance. The accelerated reduction in principal lets you pay less interest over the life of the loan than what is shown on the original amortization schedule and you pay the loan off faster.
In terms of return on your money, think of paying additional to the mortgage as putting that money in a CD paying the same rate as the mortgage's interest rate. Only difference is you can't "redeem" that CD until you sell the property.
Re: Please explain "pocket-change prepayments" on a mortgage
This is correct. Any time you pay extra on the principal, you will reduce the term of the loan. No big secret. It will change your amortization schedule because your original schedule assumes you make regular payments.bigred77 wrote: If you send in a payment that's higher than the required amount, the additional amount is applied to the principal balance. The accelerated reduction in principal lets you pay less interest over the life of the loan than what is shown on the original amortization schedule and you pay the loan off faster.
Slow and steady wins the race.
Re: Please explain "pocket-change prepayments" on a mortgage
Does anyone know of a calculator that spits out the real total cost of a mortgage, incorporating both federal/state interest tax deductions and inflation adjustment?
Re: Please explain "pocket-change prepayments" on a mortgage
So I tried to calculate the tax & inflation-adjusted total cost of my mortgage. Can someone check my math? I'm sure my code is inefficient.
data mortgage;
input loan duration interest fedtax statetax inflation;
datalines;
236000 30 3.125 25 6.45 -1
236000 30 3.125 25 6.45 0
236000 30 3.125 25 6.45 1
236000 30 3.125 25 6.45 2
236000 30 3.125 25 6.45 3
236000 30 3.125 25 6.45 4;
data mortgage;
set mortgage;
nominal_payment = ((interest/1200)*loan) / (1-(1+(interest/1200))**(-1*(duration*12)));
nominal_cost = nominal_payment*duration*12;
tax_adj_int = (interest - (interest*(fedtax/100))) - (interest*(statetax/100));
tax_adj_payment = ((tax_adj_int/1200)*loan) / (1-(1+(tax_adj_int/1200))**(-1*(duration*12)));
tax_adj_cost = tax_adj_payment*duration*12;
array infl {360} infl_tax_adj_payment1-infl_tax_adj_payment360;
do i=1 to 360;
infl{i} = tax_adj_payment*((1+(inflation/100))**(-i));
end;
infl_tax_adj_cost = sum(of infl_tax_adj_payment1-infl_tax_adj_payment360);
run;
I this is correct, the results are quite staggering on a 30 year $236k mortgage at 3.125% and a 25% fed, 6.45% state marginal tax brackets:
inflation nominal_cost tax_adj_cost infl_tax_adj_cost
-1% $363947.78 $320104.03 $3224823.45
0% $363947.78 $320104.03 $320104.03
1% $363947.78 $320104.03 $86444.39
2% $363947.78 $320104.03 $44423.26
3% $363947.78 $320104.03 $29638.55
4% $363947.78 $320104.03 $22229.43
data mortgage;
input loan duration interest fedtax statetax inflation;
datalines;
236000 30 3.125 25 6.45 -1
236000 30 3.125 25 6.45 0
236000 30 3.125 25 6.45 1
236000 30 3.125 25 6.45 2
236000 30 3.125 25 6.45 3
236000 30 3.125 25 6.45 4;
data mortgage;
set mortgage;
nominal_payment = ((interest/1200)*loan) / (1-(1+(interest/1200))**(-1*(duration*12)));
nominal_cost = nominal_payment*duration*12;
tax_adj_int = (interest - (interest*(fedtax/100))) - (interest*(statetax/100));
tax_adj_payment = ((tax_adj_int/1200)*loan) / (1-(1+(tax_adj_int/1200))**(-1*(duration*12)));
tax_adj_cost = tax_adj_payment*duration*12;
array infl {360} infl_tax_adj_payment1-infl_tax_adj_payment360;
do i=1 to 360;
infl{i} = tax_adj_payment*((1+(inflation/100))**(-i));
end;
infl_tax_adj_cost = sum(of infl_tax_adj_payment1-infl_tax_adj_payment360);
run;
I this is correct, the results are quite staggering on a 30 year $236k mortgage at 3.125% and a 25% fed, 6.45% state marginal tax brackets:
inflation nominal_cost tax_adj_cost infl_tax_adj_cost
-1% $363947.78 $320104.03 $3224823.45
0% $363947.78 $320104.03 $320104.03
1% $363947.78 $320104.03 $86444.39
2% $363947.78 $320104.03 $44423.26
3% $363947.78 $320104.03 $29638.55
4% $363947.78 $320104.03 $22229.43
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Re: Please explain "pocket-change prepayments" on a mortgage
Correct.jhfenton wrote:I'm not sure what the magic of two checks (or two ACH payments) per month is, either. If I pay extra on my mortgage, it automatically goes to principal.
I used to just round up my monthly payment to the next $100 or so.
No need to make distinct extra payments in most cases.
Having said that, now in semi-retirement, I have income hitting my checking account about five times each month, so I sometimes do indeed make extra payments to a CC account or my modest HELOC in addition to regular payments...
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Re: Please explain "pocket-change prepayments" on a mortgage
My HELOC is structured differently.Abe wrote:This is correct. Any time you pay extra on the principal, you will reduce the term of the loan. No big secret. It will change your amortization schedule because your original schedule assumes you make regular payments.bigred77 wrote: If you send in a payment that's higher than the required amount, the additional amount is applied to the principal balance. The accelerated reduction in principal lets you pay less interest over the life of the loan than what is shown on the original amortization schedule and you pay the loan off faster.
Excess payment amounts reduce the require payment amounts for subsequent months by a small amount, keeping the theoretical term the same...
Attempted new signature...
Re: Please explain "pocket-change prepayments" on a mortgage
I was referring to a standard mortgage loan. I am not familiar with home equity loans. Generally speaking most mortgage loans do not have provisions in the note that would prevent making additional payments on the principal. Anyone getting a loan should read and understand the promissory note before signing, whether it be a standard mortgage loan or a home equity loan. I guess there could be provisions preventing pre-payment or maybe a pre-payment penalty. I wouldn't rely on the lender to tell you what you can or cannot do. Read you note yourself. If there is nothing in the note to prevent pre-payment then you should be able to do it and extra payments should be applied to principal. I am not a lawyer. What I am telling you is just from my experience.The Wizard wrote: My HELOC is structured differently.
Excess payment amounts reduce the require payment amounts for subsequent months by a small amount, keeping the theoretical term the same...
Slow and steady wins the race.
Re: Please explain "pocket-change prepayments" on a mortgage
Mortgages are not what they used to be. I remember looking at my mom's coupon book back in the 80s and it was some far off futuristic date like 1998 or year 24 out of 30 before the principal on the payment equalled the interest. By contrast, the very first payment on my current mortgage had a 5:4 ratio of principal:interest. That is admittedly on a 20 year note, but it still blew me away to pay more principal on payment #1.
Like others have said, there's nothing magic about paying extra principal each month. When interest rates were 10%+ it was a no brainier. With today's 3.XX% rates it's only marginally better than sticking the money in a high yield CD at best.
Like others have said, there's nothing magic about paying extra principal each month. When interest rates were 10%+ it was a no brainier. With today's 3.XX% rates it's only marginally better than sticking the money in a high yield CD at best.
Re: Please explain "pocket-change prepayments" on a mortgage
Deleted: double post
Last edited by Abe on Sat Apr 02, 2016 11:21 am, edited 1 time in total.
Slow and steady wins the race.
Re: Please explain "pocket-change prepayments" on a mortgage
I got this from the Mortgage Professors website:Abe wrote:Abe wrote:I was referring to a standard mortgage loan. I am not familiar with home equity loans. Generally speaking most mortgage loans do not have provisions in the note that would prevent making additional payments on the principal. Anyone getting a loan should read and understand the promissory note before signing, whether it be a standard mortgage loan or a home equity loan. I guess there could be provisions preventing pre-payment or maybe a pre-payment penalty, but I wouldn't rely on the lender to tell you what you can or cannot do. Read you note yourself. If there is nothing in the note to prevent pre-payment then you should be able to do it and extra payments should be applied to principal. I am not a lawyer. What I am telling you is just from my experience.The Wizard wrote: My HELOC is structured differently.
Excess payment amounts reduce the require payment amounts for subsequent months by a small amount, keeping the theoretical term the same...
http://www.mtgprofessor.com/A%20-%20Sec ... _heloc.htm
Interest on a HELOC
Because the balance of a HELOC may change from day to day, depending on draws and repayments, interest on a HELOC is calculated daily rather than monthly. On a 6% HELOC, interest for a day is .06 divided by 365 or .000164, which is multiplied by the average daily balance during the month. If this is $100,000, the daily interest is $16.44, and over a 30-day month interest amounts to $493.15; over a 31 day month, it is $509.59.
In contrast, on a standard 6% mortgage, interest for the month is .06 divided by 12 or .005, multiplied by the loan balance at the end of the preceding month. If the balance is $100,000, the interest payment is $500, regardless of whether there are 30 or 31 days in the month -- or 28.
Slow and steady wins the race.
Re: Please explain "pocket-change prepayments" on a mortgage
That distinction is traditional and common, but is not always true now either. Our conventional first-mortgage refinance accrues daily interest. I even had to adjust my amortization table for this year, because they're dividing 3.74% (our interest rate) this year by 366 days instead of 365. I couldn't figure it out at first because they changed it on January 1st, mid-month between our 12/21/15 mortgage payment and our 01/21/15 mortgage payment. Nothing I tried in my formula initially could account for why my January interest charge was $0.58 less than expected. I finally figured out that they were charging us 11 days at 3.74%/365 and 20 days at 3.74%/366.Abe wrote: I got this from the Mortgage Professors website:
http://www.mtgprofessor.com/A%20-%20Sec ... _heloc.htm
Interest on a HELOC
Because the balance of a HELOC may change from day to day, depending on draws and repayments, interest on a HELOC is calculated daily rather than monthly. On a 6% HELOC, interest for a day is .06 divided by 365 or .000164, which is multiplied by the average daily balance during the month. If this is $100,000, the daily interest is $16.44, and over a 30-day month interest amounts to $493.15; over a 31 day month, it is $509.59.
In contrast, on a standard 6% mortgage, interest for the month is .06 divided by 12 or .005, multiplied by the loan balance at the end of the preceding month. If the balance is $100,000, the interest payment is $500, regardless of whether there are 30 or 31 days in the month -- or 28.
(In days gone by, my Sallie Mae student loan charged daily interest at R/365.25.)
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Re: Please explain "pocket-change prepayments" on a mortgage
OP should also note that "next month's principal " will continually escalate, especially by prepaying the principal. The more you prepay, the more principal is in your next payment, which means under this week system the more you have to prepay the following month.
There are lots of calculators online showing how various one time or repeated prepayments affect total interest paid and loan payoff date.
Regarding 15 vs 30 year loans, the rate spread is only about 50 basis points. To my mind that's not enough reward for the significantly higher payments and reduced flexibility of the 15 year. I'd rather get the thirty year, prepay if and when I want, and have the ability to drop back if I ever need.
There are lots of calculators online showing how various one time or repeated prepayments affect total interest paid and loan payoff date.
Regarding 15 vs 30 year loans, the rate spread is only about 50 basis points. To my mind that's not enough reward for the significantly higher payments and reduced flexibility of the 15 year. I'd rather get the thirty year, prepay if and when I want, and have the ability to drop back if I ever need.
Re: Please explain "pocket-change prepayments" on a mortgage
This thread is now in the Personal Finance (Not Investing) forum (mortgage).
Re: Please explain "pocket-change prepayments" on a mortgage
Not necessarily; the OP should check his mortgage documentation carefully and discuss with his lender if necessary. When I got my mortgage, I was told in no uncertain terms that any payments in excess of my normal monthly payments would be considered an early payment for the following month. So, if I paid twice what I was supposed to pay in June, I could skip my July payment and would be back on schedule in August. I suppose there would have been some kind of true-up if I continued to pay ahead for the entire duration of the mortgage, but I was clearly told that, if I wanted to make extra payment to principal, I had to make a second payment with a notation to "Apply payment to principal only."bigred77 wrote:If you send in a payment that's higher than the required amount, the additional amount is applied to the principal balance.
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Re: Please explain "pocket-change prepayments" on a mortgage
This is basically what we did to pay off our mortgage in under 15 years. Our rate was 9.75%. I wrote out my own amortization schedule on the back of an envelope. Each month I tried to add at least one extra month's worth of principal payment, often 3 months in the beginning was less than $100. Our tax refunds (refundable credits) were always earmarked to be applied to principal. One year I also added in a small inheritance; that $15k payment knocked out 8 years of principal payments! After our student loans were paid off, I added that amount as well.whomever wrote:The effect is more dramatic at higher interest rates. Our first (and only!) mortgage was something like 9%.
Here are the first few payments for a $100K, 9%, 30 yr mortgage, broken down into principal and interest (rounded to nearest dollar):
Payment# Principle Interest
1 55 750
2 55 750
3 55 749
4 56 749
5 56 748
6 57 748
So, if on month 1 you have an extra $110 handy, you send in the normal payment (750+55=805) plus the principle for payments #2 and 3 (55+55=110). That $110 means you have now made payment #2 and 3. You don't get to skip two months, but next month when you send in the $805, you're making payment #4. You never pay the $750 in interest for payment #2 or the $749 for payment #3.
Of course, toward the end of the mortgage, the proportions flip, and it's harder to do. Early on, though, it feels pretty good to get a tax refund or whatever and make 6 months worth of payments.
Plug your numbers into a calculator (like http://www.bankrate.com/calculators/mor ... lator.aspx - 'calculate' and then 'show amortization schedule') and print out the schedule, and have fun every month drawing lines through however many payments you can cross off.
By the time you are nearing the end, the interest payments are small and doubling principal payments is more difficult, which is why I tried to front load the payments. The last year we just paid on schedule, and redirected tax refunds to Roth IRAs instead.
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Re: Please explain "pocket-change prepayments" on a mortgage
So according to your calculations, at the beginning of a 30 year 9% mortgage an extra payment ($805) knocks out more than a year's worth (about 16 months) of payments? Does that mean doing three extra payments at the beginning would knock out almost 5 years? That seems hard to believe. The mortgage professor calculator says it would knock out only 37 months.whomever wrote:The effect is more dramatic at higher interest rates. Our first (and only!) mortgage was something like 9%.
Here are the first few payments for a $100K, 9%, 30 yr mortgage, broken down into principal and interest (rounded to nearest dollar):
Payment# Principle Interest
1 55 750
2 55 750
3 55 749
4 56 749
5 56 748
6 57 748
So, if on month 1 you have an extra $110 handy, you send in the normal payment (750+55=805) plus the principle for payments #2 and 3 (55+55=110). That $110 means you have now made payment #2 and 3. You don't get to skip two months, but next month when you send in the $805, you're making payment #4. You never pay the $750 in interest for payment #2 or the $749 for payment #3.
Of course, toward the end of the mortgage, the proportions flip, and it's harder to do. Early on, though, it feels pretty good to get a tax refund or whatever and make 6 months worth of payments.
Plug your numbers into a calculator (like http://www.bankrate.com/calculators/mor ... lator.aspx - 'calculate' and then 'show amortization schedule') and print out the schedule, and have fun every month drawing lines through however many payments you can cross off.
At lower interest rates the effect is far less impressive. On my 3.625 mortgage, 3 extra payments in the first month only foreshorten the payoff date by 9 months.
Re: Please explain "pocket-change prepayments" on a mortgage
Letsgobobby:
You can't just multiply the first month's principal amount by N months - the principal amount goes up each month. For a 30 yr/9% loan, the principal is in the $70 range by the 36th payment. You have to sum the amounts month by month.
If you are suggesting that the mortgage calculator I used has a bug, it might. Or the one you checked it against might. Or they might both be wrong. I just used the first one google found. When I was paying off my own mortgage, I wrote my own (in FORTRAN!) and carefully validated it. I didn't do any of that for this example.
The principle of principal prepayment stands regardless of actual numbers: especially at high interest rates, modest principal prepayments can dramatically accelerate mortgage payoff.
You can't just multiply the first month's principal amount by N months - the principal amount goes up each month. For a 30 yr/9% loan, the principal is in the $70 range by the 36th payment. You have to sum the amounts month by month.
If you are suggesting that the mortgage calculator I used has a bug, it might. Or the one you checked it against might. Or they might both be wrong. I just used the first one google found. When I was paying off my own mortgage, I wrote my own (in FORTRAN!) and carefully validated it. I didn't do any of that for this example.
The principle of principal prepayment stands regardless of actual numbers: especially at high interest rates, modest principal prepayments can dramatically accelerate mortgage payoff.
Re: Please explain "pocket-change prepayments" on a mortgage
With this mortgage: 360 months, 9%, $100k original loan, $804.62 payment. If a $805.00 principal payment is made at the beginning of the loan, that leaves $99,195. loan balance which would amortize out in roughly 346 months or knock off 14 payments. If a $2,414. principal payment (roughly 3 payments) is made at the beginning of the loan, that leaves $97,586. loan balance which would amortize out at roughly 322 payments or knock off 38 payments.letsgobobby wrote: So according to your calculations, at the beginning of a 30 year 9% mortgage an extra payment ($805) knocks out more than a year's worth (about 16 months) of payments? Does that mean doing three extra payments at the beginning would knock out almost 5 years? That seems hard to believe. The mortgage professor calculator says it would knock out only 37 months.
Slow and steady wins the race.
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Re: Please explain "pocket-change prepayments" on a mortgage
Agreed, just over three years.
The math is less impressive with modern interest rates. Prepaying a mortgage just doesn't have the same bite at 3.5% as it did at 9%. Looking at my loan, one early payment knocks off no more than 3 months, a "1:3 ratio" compared to the "1:9" ratio at 9%. And for that you lose the liquidity of the funds for almost 30 years.
The math is less impressive with modern interest rates. Prepaying a mortgage just doesn't have the same bite at 3.5% as it did at 9%. Looking at my loan, one early payment knocks off no more than 3 months, a "1:3 ratio" compared to the "1:9" ratio at 9%. And for that you lose the liquidity of the funds for almost 30 years.
Re: Please explain "pocket-change prepayments" on a mortgage
If you can get a higher return investing the money than the interest rate on the mortgage, you may want to invest the money and not pay down the loan. Of course some people would rather get the mortgage paid off as soon as possible regardless. So, like a lot of things, it depends on the individual.
Slow and steady wins the race.
Re: Please explain "pocket-change prepayments" on a mortgage
I'd submit that the real lesson here is to not think of a '30 year' mortgage. Instead view it as a '360 payment' mortgage. My sense is that, psychologically, many people just get on the 30 year schedule and don't consider prepaying when some extra money happens along. For us, drawing red lines through a block of payments every month was a very compelling reminder. We kept the schedule up on a bulletin board . When phrased as 'do we want to spent that $200 on fun thing Z or cross off an extra couple of payments, we often decided crossing off payments was more fun.
When you prepay early, you avoid many years of interest on the prepaid amount. That's nice whenever the mortgage interest is greater than the current rate for CD's or other safe investment, whether it's 9% mortgage/7% CD, or 4% mortgage/2% CD.
As Abe says, if you have a 3% mortgage and CD's are paying 5%, don't prepay.
Losing flexibility is a tougher question. If the current rates are 4% mortgage/2% CD and you prepay, you can't later use the money you used to prepay to get a 5% CD if rates rise. That's certainly a greater concern today than when rates were at historic highs. OTOH, both our parent's families experienced dire personal consequences during the depression from an inability to pay rent/mortgage, and growing up hearing those stories made us very happy to pay off the mortgage. Either way, you pays yer money and takes yer chances
When you prepay early, you avoid many years of interest on the prepaid amount. That's nice whenever the mortgage interest is greater than the current rate for CD's or other safe investment, whether it's 9% mortgage/7% CD, or 4% mortgage/2% CD.
As Abe says, if you have a 3% mortgage and CD's are paying 5%, don't prepay.
Losing flexibility is a tougher question. If the current rates are 4% mortgage/2% CD and you prepay, you can't later use the money you used to prepay to get a 5% CD if rates rise. That's certainly a greater concern today than when rates were at historic highs. OTOH, both our parent's families experienced dire personal consequences during the depression from an inability to pay rent/mortgage, and growing up hearing those stories made us very happy to pay off the mortgage. Either way, you pays yer money and takes yer chances
Re: Please explain "pocket-change prepayments" on a mortgage
I would recommend to anyone interested in anything financial getting a pocket financial calculator and learning how to use it. I know we have spread sheets now or calculators online, but I still like having my pocket calculator handy. I use the Texas Instrument BAII Plus which you can buy at Walmart for around 30 bucks. I know a lot of people like the Hewlett Packard HP-12c or whatever and that's fine if you already know how to use it. The Texas Instrument is easier to learn how to use and is cheaper. All the calculations I made on this thread were on my TI calculator.
Slow and steady wins the race.
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Re: Please explain "pocket-change prepayments" on a mortgage
I think the easiest way to do this would be first to subtract the fraction of interest subsidized by the IRS and your state revenue dept from the loan interest rate to get the net effective nominal rate, and then calculate the real rate using the relationship between nominal rate i, inflation rate f, and real rate r, that is:evarrr wrote:Does anyone know of a calculator that spits out the real total cost of a mortgage, incorporating both federal/state interest tax deductions and inflation adjustment?
(1 + i) = (1 + f) × (1 + r)
or
r = ((1+i)/(1+f)) - 1 = (i - f)/(1+f)
Then amortize using the effective real rate r. This will give you the net mortgage cost in real terms. For low inflation rates, r = i - f is an often used reasonable estimate for r.
Of course, neither inflation, nor one's tax rates are constant for 30 years, nor do many people hold a mortgage for 30 years. Technically, you also need to consider the holding period of the loan. The shorter the holding period, the higher the APR because the closing costs are amortized over fewer payments.