A "different" paying off the mortgage question

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slow n steady
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A "different" paying off the mortgage question

Post by slow n steady »

I've decided I want to pay off my mortgage as soon as possible.

I don't have the necessary funds to pay off the entire note.

Question: If it is going to take me 5 years to pay off my mortgage, wouldn't it be better to put "extra" money in CD's or a savings account and pay off the mortgage all at once instead of applying it to the mortgage slowly over time.



I believe that extra payments on a mortgage don't effect the amount of interest that you are paying until you pay it all off or refinance. I think recasting just changes the amount off principal that you are paying but keeps the amount of interest the same.
Correct me if I am wrong please :?
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Post by SharkSoul »

I think you are correct. You pretty much always have to pay interest, but initially you are paying more interest than principal and interest is a tax write off, while the principal isn't. So it would be better to pay it off at the tail end of your mortgage. That's why people couple their mortgages with life insurance, so that they can accelerate their mortgage payments.
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trees
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Post by trees »

It depends on the bank. My interest owed is affected by extra principal payments.
Tabl83
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Post by Tabl83 »

This is my first post.

Personally I would say that you are better off putting money directly into the loan.

Example:
$100,000 30 year loan @ 5%
monthly payment is 536.62
If you add an additional $200 to the principle every month you will be done in 16 years (201 months) and will save $45,548 in interest

If you were to invest $200 a month for 16 year at 6% you would earn $28,803 in interest.

So if you look at it only in terms of NPV in this situation the additional principle payment is the better option.
letsgobobby
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Re: A "different" paying off the mortgage question

Post by letsgobobby »

slow n steady wrote:I've decided I want to pay off my mortgage as soon as possible.

I don't have the necessary funds to pay off the entire note.

Question: If it is going to take me 5 years to pay off my mortgage, wouldn't it be better to put "extra" money in CD's or a savings account and pay off the mortgage all at once instead of applying it to the mortgage slowly over time.



I believe that extra payments on a mortgage don't effect the amount of interest that you are paying until you pay it all off or refinance. I think recasting just changes the amount off principal that you are paying but keeps the amount of interest the same.
Correct me if I am wrong please :?
I think you're wrong. When you send an extra payment to your lender and label it, "Apply to principal," your future payments will remain the same, but the amount being applied to principal will be increased in each remaining payment (and thus the amount applied to interest reduced) because there is a smaller amount being lent. You will also have eliminated some amount of future payments (lopped off the end) but you wouldn't see this immediately, of course.

If you ask for your loan to be recasted, you are asking for the total monthly payment to be reduced based on your reduced loan balance. This would probably only be worthwhile if you made a large lump sum payment and then were concerned about ongoing cash flow (ie, your situation changed).

Regardless of whether you recast or not, when you apply additional money to the principal of a loan, the total interest owed will be reduced.

With regards to your specific proposal, it makes no sense. Money invested in the CD will not earn the same interest as what your mortgage is costing you; if it were, you wouldn't be paying off the mortgage. Therefore you are better off sending every dollar to your lender as soon as you can, marking each such dollar with a clear sign, "apply to principal."
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G-Money
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Post by G-Money »

Reductions in principal reduce the amount of interest that accrues each subsequent month.

It is true with most mortgages that the amount owed each month does not change after you make additional payments toward principal. But this simply means you are paying more toward principal each successive month than you would had you not made the additional principal payment.

Play around with an amortization table to see how this works.
Colorado13
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Post by Colorado13 »

I recommend that you play around with the numbers/try different scenarios using the calculator at bankrate.com. I've found it to be really useful in determining the impact of one-time lump sum loan payments, extra loan payments, etc. The calculator will show you exactly how much interest you are paying under various scenarios.
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Bruce
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Post by Bruce »

Hugh Chou's excellant website has a very good set of financial calculators

http://www.hughchou.org/calc/

In particular, this one may help you decide on the answer to your scenario.

Prepay or Inveat

http://www.hughchou.org/calc/prepay_v_invest.cgi

regards
Bruce | | Winner of the 2017 Bogleheads Contest | | "Simplicity is the master key to financial success."
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FNK
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Post by FNK »

The decision is remarkably simple. If the mortgage interest rate is higher than the savings interest rate, pay into the mortgage. If you're deducting mortgage interest from taxes, reduce the mortgage interest rate by your marginal tax rate (e.g. 6% reduced by 25% is 4.5%).

Monthly payment amount is not the relevant information. If you prepay the mortgage, you will be required to pay the same monthly amount, but you'll pay it off much sooner.

You want your principal pulling interest as small as possible at all times.
Breezy
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Post by Breezy »

Not taking into effect the interest savings, etc., I did what you're thinking of doing because I wanted to have the cash "in case" something came up, such as a life change where I'd need the savings.

Once I had enough saved up to pay it off as well as a solid emergency fund, I paid it off. Felt great!
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slow n steady
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Post by slow n steady »

Thanks letsgobobby and g-money, I didn't know that more would go to the principal out of each payment. I'll check with my mortgage holder to be sure. This makes it a lot simpler.
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Post by Sulvar »

If you're deducting mortgage interest from taxes, reduce the mortgage interest rate by your marginal tax rate (e.g. 6% reduced by 25% is 4.5%).
If you are going to do this, you also need to figure out the after tax return of a CD or other investment as well to compare apples to apples.
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Re: A "different" paying off the mortgage question

Post by White Coat Investor »

slow n steady wrote: I believe that extra payments on a mortgage don't effect the amount of interest that you are paying until you pay it all off or refinance. I think recasting just changes the amount off principal that you are paying but keeps the amount of interest the same.
Correct me if I am wrong please :?
You are wrong. Paying down a mortgage is exactly like a guaranteed fixed income investment at the same rate as your after-tax mortgage rate.

You would need a VERY low mortgage rate to justify investing in CDs, paying the taxes on the proceeds, and then using the proceeds to pay off the mortgage.
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Post by Userdc »

slow n steady wrote:Thanks letsgobobby and g-money, I didn't know that more would go to the principal out of each payment. I'll check with my mortgage holder to be sure. This makes it a lot simpler.
Just check to make sure you don't have a prepayment penalty that is still in effect.

It's extremely unlikely that you'd have a defeasance or yield maintenance clause that would require you to make the lender whole for lost interest due to prepayment. This is common in commercial mortgages, but I've never heard of it for residential and it would likely be illegal in most states, which place limits on the level and term of prepayment penalties for residential mortgages.
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zzcooper123
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Post by zzcooper123 »

The decision to pay off the mortgage is behavioral. If you would normally have "blown" the cash on trips, big screen TVs etc., then "invest" in your mortgage. Remember missed opportunity costs. Once you fail to fund an IRA/401k for the year, you can't get it back. You can't eat home equity.
Long term mortgages are good inflation hedges and asset protectors. Home equity is not counted toward need-based college money.
The question might be; is a mortgage a good savings vehicle?
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Re: A "different" paying off the mortgage question

Post by grabiner »

slow n steady wrote:I've decided I want to pay off my mortgage as soon as possible.

I don't have the necessary funds to pay off the entire note.

Question: If it is going to take me 5 years to pay off my mortgage, wouldn't it be better to put "extra" money in CD's or a savings account and pay off the mortgage all at once instead of applying it to the mortgage slowly over time.
It's better to put the extra money towards the mortgage, because...
I believe that extra payments on a mortgage don't effect the amount of interest that you are paying until you pay it all off or refinance.
This is not correct. Extra payments do not reduce the monthly payment due until the mortgage is gone or refinanced, but interest accumulates on the current balance. If you are currently paying $1000 a month on a 4.9% mortgage (0.4% per month) with a current balance due of $200,000, then you have $800 of interest accruing each month, and the other $200 goes to principal. If you pay down the balance by $10,000 then you will still owe $1000 the next month, but only $760 goes to interest and $240 to principal, so the following month's principal will be $10,040 less. That is, you earned 0.4% per month, or 4.9% per year, on your prepayment.

The earnings on the prepayment are taxable; the $40 less you paid in interest is no longer a deduction on your taxes. However, the earnings on a CD investment while waiting to make the prepayment are also taxable; therefore, you will come out ahead unless you can earn a higher rate on a CD than on your mortgage.
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Post by DSInvestor »

Making extra principal payments decreases the principal which decreases the interest going forward. For fixed rate loans, your monthly payment will not change after you have made extra principal payments. The payments stay the same but since you're paying less interest, you're paying more principal with each payment. This will accelerate your mortgage payoff.

Here's a mortgage calculator where you can enter some prepayments and see an amortization report showing the amounts of principal and interest paid for the regular schedule and the prepayment schedule. You will see less interest paid in the prepayment schedule. The calculator has options for monthly, yearly or one-time prepayments. Click view report to see the amortization report.
http://www.dinkytown.net/java/MortgageLoan.html

Here's a link to Mortgage Professor's page on Mortgage Amortization which has some calculators and spreadsheets for you to run some scenarios:
http://www.mtgprofessor.com/A%20-%20Amo ... s_work.htm
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stemikger
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Re: A "different" paying off the mortgage question

Post by stemikger »

EmergDoc wrote:
slow n steady wrote: I believe that extra payments on a mortgage don't effect the amount of interest that you are paying until you pay it all off or refinance. I think recasting just changes the amount off principal that you are paying but keeps the amount of interest the same.
Correct me if I am wrong please :?
You are wrong. Paying down a mortgage is exactly like a guaranteed fixed income investment at the same rate as your after-tax mortgage rate.

You would need a VERY low mortgage rate to justify investing in CDs, paying the taxes on the proceeds, and then using the proceeds to pay off the mortgage.
I agree with the above. However, if you don't have a big emergency fund and would feel more secure having the money liquid - you may want to put it in a savings account. However, if you already have an adequate EF then it would make more sense to put it all towards the mortgage.
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stemikger
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Re: A "different" paying off the mortgage question

Post by stemikger »

slow n steady wrote:I've decided I want to pay off my mortgage as soon as possible.

I don't have the necessary funds to pay off the entire note.

Question: If it is going to take me 5 years to pay off my mortgage, wouldn't it be better to put "extra" money in CD's or a savings account and pay off the mortgage all at once instead of applying it to the mortgage slowly over time.



I believe that extra payments on a mortgage don't effect the amount of interest that you are paying until you pay it all off or refinance. I think recasting just changes the amount off principal that you are paying but keeps the amount of interest the same.
Correct me if I am wrong please :?
I am doing a similiar thing and am on target to be mortgage free July 2012. I am currently putting in all extra money in my mortgage because it is a guranteed investment in such uncertain times. True it is not liquid, but without a mortgage payment every month can you imagine the extra you can put toward your investments. Also, the piece of mind knowing you can't lose your home if you get laid off.
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Re: A "different" paying off the mortgage question

Post by Grt2bOutdoors »

stemikger wrote:
slow n steady wrote:I've decided I want to pay off my mortgage as soon as possible.

I don't have the necessary funds to pay off the entire note.

Question: If it is going to take me 5 years to pay off my mortgage, wouldn't it be better to put "extra" money in CD's or a savings account and pay off the mortgage all at once instead of applying it to the mortgage slowly over time.



I believe that extra payments on a mortgage don't effect the amount of interest that you are paying until you pay it all off or refinance. I think recasting just changes the amount off principal that you are paying but keeps the amount of interest the same.
Correct me if I am wrong please :?
I am doing a similiar thing and am on target to be mortgage free July 2012. I am currently putting in all extra money in my mortgage because it is a guranteed investment in such uncertain times. True it is not liquid, but without a mortgage payment every month can you imagine the extra you can put toward your investments. Also, the piece of mind knowing you can't lose your home if you get laid off.
Failure to pay taxes can lead to a large lien and ultimate foreclosure for non-payment. Many who lost homes during the Great Depression were for non-payment of taxes owed.
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stemikger
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Re: A "different" paying off the mortgage question

Post by stemikger »

GRT2BOUTDOORS wrote:
stemikger wrote:
slow n steady wrote:I've decided I want to pay off my mortgage as soon as possible.

I don't have the necessary funds to pay off the entire note.

Question: If it is going to take me 5 years to pay off my mortgage, wouldn't it be better to put "extra" money in CD's or a savings account and pay off the mortgage all at once instead of applying it to the mortgage slowly over time.



I believe that extra payments on a mortgage don't effect the amount of interest that you are paying until you pay it all off or refinance. I think recasting just changes the amount off principal that you are paying but keeps the amount of interest the same.
Correct me if I am wrong please :?
I am doing a similiar thing and am on target to be mortgage free July 2012. I am currently putting in all extra money in my mortgage because it is a guranteed investment in such uncertain times. True it is not liquid, but without a mortgage payment every month can you imagine the extra you can put toward your investments. Also, the piece of mind knowing you can't lose your home if you get laid off.
Failure to pay taxes can lead to a large lien and ultimate foreclosure for non-payment. Many who lost homes during the Great Depression were for non-payment of taxes owed.
This is true, and that is why I chose to live in a house I could afford with taxes I could afford (even in a layoff). Also, if I lost my job, I rather have a payment of $300 a month compared to $1,700 a month.
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DiscoBunny1979
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Post by DiscoBunny1979 »

Another issue to consider when paying off the mortgage is types of insurance coverage. I'm contributing an extra $400 a month on my loan, but am concerned that once the loan gets to a certain point, where the equity is "too large to risk" then I might consider adding Earthquake coverage. On my house, that means an extra $1,000 a year for such coverage. It varies depending upon zip code location in CA. So, even if the house is paid off, some costs might actually increase!

One tool I use for payoff is Excel. I can adjust the $400 extra to any dollar amount and see what the impact is on the balance over time. I can say that adding extra to principal gives me a good feeling that I'm being an active participant in my financial well being. But, once the money is paid, I can't ask for it back. Therefore, I make sure that the emergency fund is funded and that contributions to the IRA/401K is maxed before paying extra on the mortgage.

The problem with paying off the mortgage in one lump sum is that once you do that, the money is spent. In my case, where there is no way to determine if the next Earthquake that might happen will level my house, I don't feel it's in my best interest to pay off the loan, when the lump sum could be used as additional "emergency" funds to find another house somewhere else. Because insurance coverage may take a while to kick in, it's important to have a Plan C in my opinion. For instance, the insurance may pay for a certain $$ in monthly living expenses when a house needs to be repaired or rebuilt, but it might not be enough to cover the cost of relocating a base of operation for whatever one does in their private residence.
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Post by stemikger »

DiscoBunny1979 wrote:Another issue to consider when paying off the mortgage is types of insurance coverage. I'm contributing an extra $400 a month on my loan, but am concerned that once the loan gets to a certain point, where the equity is "too large to risk" then I might consider adding Earthquake coverage. On my house, that means an extra $1,000 a year for such coverage. It varies depending upon zip code location in CA. So, even if the house is paid off, some costs might actually increase!

One tool I use for payoff is Excel. I can adjust the $400 extra to any dollar amount and see what the impact is on the balance over time. I can say that adding extra to principal gives me a good feeling that I'm being an active participant in my financial well being. But, once the money is paid, I can't ask for it back. Therefore, I make sure that the emergency fund is funded and that contributions to the IRA/401K is maxed before paying extra on the mortgage.

The problem with paying off the mortgage in one lump sum is that once you do that, the money is spent. In my case, where there is no way to determine if the next Earthquake that might happen will level my house, I don't feel it's in my best interest to pay off the loan, when the lump sum could be used as additional "emergency" funds to find another house somewhere else. Because insurance coverage may take a while to kick in, it's important to have a Plan C in my opinion. For instance, the insurance may pay for a certain $$ in monthly living expenses when a house needs to be repaired or rebuilt, but it might not be enough to cover the cost of relocating a base of operation for whatever one does in their private residence.
Good Point.
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Thanks!

Post by raisin mountaineer »

Good thread. I have about $50K left on my mortgage at 5.25%. I've been kinda saving money up to pay it off, but that same money is also earmarked for several other "maybe" targets and issues. Based on this advice, I'm taking $10K for sure and paying down that much, and feeling good about crossing out that a fair amount of interest, even if I can't pay off the whole loan right now.
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Re: Thanks!

Post by stemikger »

raisin mountaineer wrote:Good thread. I have about $50K left on my mortgage at 5.25%. I've been kinda saving money up to pay it off, but that same money is also earmarked for several other "maybe" targets and issues. Based on this advice, I'm taking $10K for sure and paying down that much, and feeling good about crossing out that a fair amount of interest, even if I can't pay off the whole loan right now.
Good Luck raisin. I kind of did it like this also. I have to say the last big chunk of money I put down was 10K and I know it was only emotional but watching the principal go down that much over night was a great feeling.

This is one of those choices where even many of the main financial gurus (both good and bad) disagree. I think in the long run it is one more based on emotions and having piece of mind and too me that is almost worth ignoring the math for a short period.

I'm 47 and my principal balances as of today is $29,900 and by this time next year I should be mortgage free!!! I know my life will not be dramatically changed by this event, but I will definitely feel piece of mind.

P.S. There are many brilliant folks here (I am definitely not one of them). I am just an average Joe who likes to keep things as simple as possible (i.e. David Bach and Dave Ramsey style), but even with all the brilliant advice here, I am ultimately responsible for my own financial decisions and trust myself at the end of the day.
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Post by adave »

I vote for paying off the note. I really don't think you can go wrong with it.

I like to calculate how much my interest payment to the bank is PER DAY. It helps put it into perspective for me how much money I hand over to the bank every time I get up in the morning. This made me want to pay it down faster.

Granted, I don't like to move so plan on staying in the home well over 10 yrs for sure.
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Post by archbish99 »

Hijacking the thread slightly, but why would you not need earthquake insurance if you have little equity? In the event of an earthquake, the house is destroyed -- but you still owe the money. You lose the asset, but don't lose the liability.

You might manage a short-sale of the lot in that case, but even then....

Can you help me understand the moving parts here?
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Post by grabiner »

archbish99 wrote:Hijacking the thread slightly, but why would you not need earthquake insurance if you have little equity? In the event of an earthquake, the house is destroyed -- but you still owe the money. You lose the asset, but don't lose the liability.
In many states, mortgages are non-recourse; if the bank forecloses on your mortgage and the house sale cannot cover the balance, you owe nothing more, even if the reason the house sale cannot cover the balance is that the house was destroyed. (However, the bank may insist that you have earthquake and flood insurance to protect its rights.)
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archbish99
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Post by archbish99 »

Ah, I see.... I'd read articles on housing in disaster areas and not seen a mention of that. Good to know!
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Post by relentless »

Something to keep in mind with mortgage repayment is that if you are borrowing at say 4.5% fixed and inflation were to increase to say 6% then bank would effectively be giving money to the borrower in real terms. OTOH, if we were to have Japan style deflation going forward, the real interest rate would be more than 4.5%. You need to decide which scenario is more likely and factor in any decision.
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