paying off fixed mortgage – question
Question: My question is about paying off a fixed mortgage. I hope it is not a stupid question (if it is stupid, blame me, not my organization, they have enough trouble already…).
Some people shorten the life of the mortgage by adding an exrta amount to their regular payment, or pay the bank an occassional lump sum. The extra amounts go to increase the equity, and therefore the life of the loan is shortened, resulting saving in the total interest paid.
Sometimes the bank will re-adjust the payments (specially if a large lump sum was paid) – in this case there is no problem.
My question is for the case when the payment is not re-adjusted and stays the same. In this case, the bank tells me that the interest part of the payments does not change (although the equity has increase above what it would be according to the original payment schedule).
The questions are then: (1) Is the bank correct ??? (2) Isn’t it better to keep the extra amount and put it in savings or in an investment and earn some interest on it. Down the road, when the loan balance will reach the accumulated amount, pay off the whole loan. If there was profit on the money, which can be assured by putting it in a CD or treasuries, the loan will be payed off sooner this way rather then paying it as the money is available. In addition there is acess to the money in case of need. ??? (3) If (2) is true how come that the usual recommendation is to make extra paymants to shorten the life of a mortgage???
Answeres will be greatly appreciated.
Answer: Some people shorten the life of the mortgage by adding an exrta amount to their regular payment, or pay the bank an occassional lump sum. The extra amounts go to increase the equity, and therefore the life of the loan is shortened, resulting saving in the total interest paid….
…when the payment is not re-adjusted and stays the same…., the bank tells me that the interest part of the payments does not change…
The questions are then: (1) Is the bank correct ???
No. You pay interest only on the remaining balance.
(2) Isn’t it better to keep the extra amount and put it in savings or in an investment and earn some interest on it.
This has been discussed in some detail on this list. The answer is: it is best to put your money where it has the most return. This typically means that you should start by paying off high-interest loans (e.g. credit cards, car loans). Then, look at possible investments. Pre-paying your mortgage is an investment at the rate of the mortgage interest. Put the money where the ROI is greater. Note also that you have more liquidity if you DO NOT pre-pay the mortgage.
Several people on the net have arguments that say that pre-paying the mortgage is generally better based on (what I and many others consider) fallacious arguments.
how come that the usual recommendation is to make extra paymants to shorten the life of a mortgage???
Because many people don’t understand the principle of calculating the present value of money. They make meaningless calculations involving (e.g.) adding up all the interest you pay over the period of the loan, without taking into account WHEN the interest is paid.
Related Posts
Filed under: Mortgage Question
Leave a Comment
XHTML: You can use these tags: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <strike> <strong>
TrackBack URL | RSS feed for comments on this post.