Posted: 8/25/2010 7:54:08 AM EDT
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I am getting one for my mortgage. Any tips on how to understand It? I have never looked at one so any instruction will be helpful.
Right now, we don't have a lot of expendable income to add onto our payment but will an extra 50 - 100 a month on principle make much of a difference? |
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YES it will make a HUGE difference.
Tip I got many years ago was to take your amortization schedule, take payment 1 and add PRINCIPAL of payment 2 and send in the check. Next month take payment 3 and add PRINCIPAL 4 and send in a check. Your payment will go up a LITTLE each month but hopefully, so will your income. Doing it this way will pay off a 30 year mortgage in 15 years and save THOUSANDS in interest. You can also pay every 2 weeks and pay it off early because you pay an extra month over the course of a year. |
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Right now, we don't have a lot of expendable income to add onto our payment but will an extra 50 - 100 a month on principle make much of a difference? ABSOLUTELY! I have owned my home since 4/2000. I throw an extra 40, 50 or 75 bucks a month into it. So far, I already knocked off 5 1/2 years off my 30 year mortgage. Think about that! If I keep it up, I will have a 30 year mortgage paid off in about 20-22 years with just a little extra each month. |
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Your schedule will look something like this: Month InterestPrincipalBalance
The interest charge is what you owe for borrowing what's left on your balance for the last month. It's not paid in advance, it applies to the last month, not the upcoming month. The principle is what is subtracted from your balance. Since your balance gets a little bit lower each time, next month's interest charges will be a tad lower as well. If you want to pay off your loan early, add enough to cover next month's principle payment. E.g. on August 10th your principle will be $135.60, now look at September's principle of $136.34. If you add an extra $136.34 to your August payment, you've just shortened your loan by a month. Do this each month and you cut your loan time in half. Of course near the end almost all of your payment goes towards principle and not interest so it'll be tougher to pay ahead |
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Banks automatically apply extra payments as forward payments. Pay $100 more today and it goes against what you'd otherwise pay next, interest and all.
It would not reduce your total payment over the course of the loan, instead merely bringing forward the final payoff date, or maybe letting you take $100 off the next scheduled payment. Depending on how they do it. NEVER make forward payments. NEVER EVER EVER MAKE FORWARD PAYMENTS. What you want to do, instead, and what your lender doesn't want you to do, is to make extra payments directly against the principal of the loan. These will obviate having to pay interest on the paid off principal over the course of the loan. Think of it in reverse terms. Say you're 65, and you have a 401k in stocks and bonds that's earned, on average, 7% a year. You began contributing to it when you were 25. The first dollar you put in to the 401k has been compounding at 7% a year for 40 years. When you were 26, that dollar had become $1.07. When you were 27, it had become $1.07x1.07 (7%), so $1.1449. At 28, it had become $1.1449x1.07, so $1.225. Notice that we're not adding 7 cents a year, we're adding 7% of the prior year's value. No difference for the first year, but a huge difference by the end. At 65, that first dollar will have compounded not to $1+[$.07 x 40 years = $2.80] = $3.80, but rather to the compound interest formula result (incorrectly assuming annual compounding rather than daily) of $14.97. That first dollar of principal thus created nearly $14 of total worth, not counting itself. The last dollar you put in, at age 64, has compounded at the same rate for only 1 year. At the time of your retirement, that dollar has turned in to only $1.07, creating a piddly 7 cents of worth. Now, let's say you have a time machine and a dollar. You can go back and contribute that dollar to your 401k at some point in the past, and then come back to the present to reap the rewards of having done so. Which year do you go back to add that new dollar? Last year, or 40 years ago? If you answered 40 years ago without hesitation, then you're doing well. So, let's go back to your mortgage. It works basically the same way as above, but in the opposite direction because you're paying down the original loan rather than building up a retirement fund. You're starting at, say, $200k and want to end up at $0, rather than starting at $0 and wanting to end up at $200k. But the concept is similar. The very last mortgage payment you make will have minimal interest, because there won't be any remaining balance to pay interest on. Because mortgage interest compounds daily, you still have to pay a bit of interest for tha last month, but not very much. Most of that payment will go to principal. But think about that last dollar of principal you pay off at the end. Every prior month in the years of your loan, you were paying down some principal as well as interest on the remaining principal. In fact, you have paid interest on that last dollar for every month of every year of the loan. If your rate is 7%, you'll have paid, as above, somewhere around $14 in interest for just $1 of principal, with that interest spread out over the life of the loan. Conversely, you paid the first dollar of principal off in the first payment, so at most you paid a cent. It'd generate 7 cents of interest if you didn't pay it off until a year after the mortgage starts, but you pay it after just a month, not an entire year. So it's under 7 cents divided by 12 months. Even lower, since it compounds daily over the year. So that first dollar you pay off, over the course of the entire loan, costs you maybe $1.01 between principal ($1) and interest ($.01). The last dollar you pay off will have, over the course of the loan, cost you over $15. $1 in principal and somewhere around or over $14 in interest. Do the time machine again. Given a dollar, do you go forward and pay off the vey next dollar of principal you'd otherwise pay off, or the very last one? Obviously, you'd pay off the very last one and then come back. That say, you'll save $14 over the course of the loan. That's called paying down the principal, and you can see why banks don't like you to do it. If you just send in a check for an unscheduled $1 payment, they'll apply it toward the next bit of money that you owe. A lot of it will go toward interest on the remaining principal. A little, maybe $.25, will go toward the principal itself. You thus aren't reducing your overall loan cost with that dollar. But if you walk in with the $1 and say "I want this applied only toward the principal of my loan, and I want you to run the new amortization table proving that it was," that enire dollar goes toward principal. Which means that you just knocked out $1 of principal that you owe, as well as the $14 of interest that you'd pay on it. You thus took down the lifetime cost of the loan by $15, rather than by just $1 the other way. HUGE difference. This is what your amortization table will show. The first payment is mostly toward interest on outstanding principal. The lwst payment is mostly toward principal, as there won't be any remaining principal after it. And you want your extra payments to thus go toward principal, rather than simply being forward applied toward your next normal payment. Follow all that? NEVER EVER EVER MAKE FORWARD PAYMENTS. Instead, fight to make sure that extra payments are applied to principal only, and then verify, no matter how much they charge you for it, that it actually was. Because they will gladly tell you that it went toward principal even when it didn't. Sometimes they're too stupid to know the difference, other times they just want their $14 of future interest. |
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Quoted: I am getting one for my mortgage. Any tips on how to understand It? I have never looked at one so any instruction will be helpful. Right now, we don't have a lot of expendable income to add onto our payment but will an extra 50 - 100 a month on principle make much of a difference? Your google broken? |
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I am getting one for my mortgage. Any tips on how to understand It? I have never looked at one so any instruction will be helpful. Right now, we don't have a lot of expendable income to add onto our payment but will an extra 50 - 100 a month on principle make much of a difference? Your google broken? No, as a matter of fact. I can read too. Does that surprise you? And I type fairly well for a guy who never went to any typing classes back when we used real typewriters. I prefered to come to this site and ask some of my fellow Arfcommers who generally give pretty good advice. That is unless you consider all the previous posters in this thread to be idiots and their advice incorrect. So go google something and post it in someone else's thread. 
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I think a quick scan of an amortization schedule will quickly illustrate how banks make money. Most of your monthly payment goes to interest for many years. You pay interest for a lot of years while paying a relatively small amount toward your principal. When I ran my schedule, it was payment 196/360 when the amount applied to principal was greater than the amount applied to interest. Also, you can see when you've finally paid for half of your outstanding amount (or 3/4 or whatever). On my schedule, it takes until payment 241/360 before I've paid off half the balance. If I pay an extra $200/mo, I've paid off half by payment 197/360. Better, but interest still sucks. You can try this calculator to see how much you gain by making extra payments. http://www.bankrate.com/calculators/mortgages/mortgage-calculator.aspx The higher your interest rate, the more you will benefit from extra principal payments. |
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Paying one extra, full payment each year on a 30 year mortgage should make that go down to 19 years.
So you can fiddle with the numbers and figure out how much $50 a month would be. Even if it only makes half a payment extra a year that is still years of interest you are taking off. Don't stop now! |
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Paying one extra, full payment each year on a 30 year mortgage should make that go down to 19 years. So you can fiddle with the numbers and figure out how much $50 a month would be. Even if it only makes half a payment extra a year that is still years of interest you are taking off. Don't stop now! Depends on whether that payment is treated as a forward payment or if it goes entirely toward principal. |
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Paying one extra, full payment each year on a 30 year mortgage should make that go down to 19 years. So you can fiddle with the numbers and figure out how much $50 a month would be. Even if it only makes half a payment extra a year that is still years of interest you are taking off. Don't stop now! Depends on whether that payment is treated as a forward payment or if it goes entirely toward principal. OP never mentioned paying part of next month's bill in advance. If the surplus is going towards next month's payment, you're doing it wrong... |
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Paying one extra, full payment each year on a 30 year mortgage should make that go down to 19 years. So you can fiddle with the numbers and figure out how much $50 a month would be. Even if it only makes half a payment extra a year that is still years of interest you are taking off. Don't stop now! Depends on whether that payment is treated as a forward payment or if it goes entirely toward principal. OP never mentioned paying part of next month's bill in advance. If the surplus is going towards next month's payment, you're doing it wrong... If you send the bank money, I don't believe they have any requirement to direct it toward principal alone. |
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Paying one extra, full payment each year on a 30 year mortgage should make that go down to 19 years. So you can fiddle with the numbers and figure out how much $50 a month would be. Even if it only makes half a payment extra a year that is still years of interest you are taking off. Don't stop now! Depends on whether that payment is treated as a forward payment or if it goes entirely toward principal. OP never mentioned paying part of next month's bill in advance. If the surplus is going towards next month's payment, you're doing it wrong... If you send the bank money, I don't believe they have any requirement to direct it toward principal alone. If you send a check with no payment stub, then there is no telling what they will do. But if you fill out your payment stub upon submission each month, there should be no issues with choosing how you wish to apply. For others interested, goof off here with the figures: http://mortgage.chase.com/pages/other/extra_payments.jsp EDIT: the 19 years may be off, as it depends on your situation and payment. I'd have to look back to see the scenario I once found all that info. |
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YES it will make a HUGE difference. Tip I got many years ago was to take your amortization schedule, take payment 1 and add PRINCIPAL of payment 2 and send in the check. Next month take payment 3 and add PRINCIPAL 4 and send in a check. Your payment will go up a LITTLE each month but hopefully, so will your income. Doing it this way will pay off a 30 year mortgage in 15 years and save THOUSANDS in interest. You can also pay every 2 weeks and pay it off early because you pay an extra month over the course of a year. Yes on the first part, I do this. Pay one month's payment, and submit an extra amount equal to principal of that payment. Does wonders. But not all places let you pay every 2 weeks. my Mort vendor only allows full payments, so you can pay every two weeks, but in whole payment increments. And they are sleazy about how they credit it. Pay today 9/1 for Septermber, then 9./15 would be applied to October, 10/1 would be for Nov, 10/15 would be for December - which is NOT helping your cause, you want to be sure the extra is applied IMMEDIATELY to the PRINCIPAL, not stored and applied for future paymets (principal, interest, taxes, insurance, etc) |