If you have not yet done so, please read part 1, part 2, part 3, part 4, part 5, part 6, part 7, and part 8 of this series first, then read on.
Last week, we started to discuss how mortgages work, showing the effect of paying a small extra principal payment along with your mortgage. Now, I’d like to offer at a glance, the require payments for a $200K, 6% fixed rate mortgage for different lengths of time:
We can see above that a small increase in monthly payments, $89, will drop the payoff from 30 years down to 25. Another $144, and it would drop down to 20 years. Again, this is simple math, not rocket science. MMA examples suggest that an additional $1000 per month and MMA will have you pay your mortgage off in 10.4 years. Look above, a 10 year mortgage has a payment $1020 higher than the 30 year mortgage. If you wish to pay your mortgage off in this amount of time, regular prepayments will achieve the same results as any expensive software.
It’s important to note that shorter term mortgages always offer a lower rate that the longer term. Typically, a 15 year will be 1/2% lower than a 30 year mortgage. What does that mean to you? It suggests that if you are aggressively paying ahead you will find that when you show you are at the 12-13 year mark (i.e. about 17-18 years left) you may be able to refinance to a 15 year loan and see only a slight increase in required payments.
More important, this implies that if you have the ability to throw all this money at the mortgage, why not consider the shorter term in the first place? This is something the agents never seem to discuss, perhaps because they don’t understand how mortgages work.
Next, let me offer another snippet of spreadsheet, this one similar to last week’s but with some additional details:
What I added above were two additional columns, one to show remaining months until the mortgage is paid off, and next, the amount of interest that you will not pay due to prepayments. You can see, the first extra payment of $1000 reduces your mortgage by an extra 5 months, so after that first payment you have only 354 payments left (plus a bit). After those first two prepayments, you are now a year into your loan, with just 29 years to go. This is from a larger spreadsheet I offer my readers, one in which you can enter your mortgage amount and interest rate. You can then track your own progress on your loan and see what impact any prepayments would have on your payoff time.
Note: The spreadsheet I referenced is available upon request only. At this point, I still prefer to track how many times I’ve sent it out, and follow up with the people who have requested it, asking for comments and questions. Please add a comment if you wish to receive a copy.
Next week, more on the HELOC shuffle.
Joe
Joe,
One quick point for all to understand… technically, interest is NOT “cancelled” in any of these pre-payment examples. Cancelling implies interest was owed (acrued) and later forgiven, e.g that the debt was reduced by the lender… this is NOT the case.
Interest accrues on a daily basis (for virtually all mortgages), calculated based on the rate and outstanding balance. If the total debt is less today, then the total interest owed is less. This is the first, and most simple but critical point consumers should understand about debt. If you pay it back sooner than required, if you make more than the minimum payment, if you owe less… then you are charged less and pay less interest!
Part of the misunderstanding (Lies) perpetuated by Ufirst / mma/ and their ilk is that their schemes somehow “saves” the consumer money… when in fact it does not.
As you show in your examples, “savings” result ENTIRELY from pre-payment of debt, with cash that is earned! Taking a shorter term loan with a lower interest rate saves even more money because both the rate and time are less.
Why pay 6% over 10.5 years when you can pay 5.5% over 10 years?
Fletch – you are correct. I suppose I allow them some poetic license to use the word “canceled” with regard to interest no longer due as a result of prepaying principal. And of course you are right in that a shorter term mortgage will have a lower rate, saving a bit more. My series still has a few weeks to run. Visit again.
Joe
kudos! … keep up the good work!
Would you please send me the mortgage calculator spreadsheet?
Thanks for all of your information.