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Posted by oparr@hotmail.com on April 24, 2008, 1:10 pm
This has probably been discussed to death so pardon me for reviving
this dead horse one more time. Back in 2004 the following post was
made in this forum;
http://groups.google.com/group/misc.invest.financial-plan/browse_frm/thread/7399c334f7a88c69/2e6829f5513bf411?lnk=st&q=mortgage+principal#2e6829f5513bf411
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I learned the hard way that extra mortgage payments are the dumbest
thing you can do. While they reduce your principal, they do not
change the amount of interest you owe on each payment because that
amortization schedule is created at the beginning of the loan. Thus,
my extra payments just went into the bank's coffers. I received no
economic benefit from that money. Now I set aside the extra mortgage
principal payment in a savings account where it earns 2% interest and
is always available to me. In six years, I will have enough aside to
pay off the balance of my mortgage. I can then decide whether I want
to pay off the mortgage or not. In the meantime, I have full access
to this money and it is earning me interest income. I could kick
myself for not realizing the stupidity of paying extra mortgage
payments to the bank sooner.
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All who replied to this post seemed to miss the point the fellow was
trying to make. Agreed, he was technically incorrect here;
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While they reduce your principal, they do not
change the amount of interest you owe on each payment because that
amortization schedule is created at the beginning of the loan.
===================================================
I think what he meant, as opposed to what he said, was that paying
down the mortage principal doesn't reduce the minimum required monthly
mortgage which is determined at the beginning of the loan. However,
paying down the mortgage principal shortens the life of the loan which
I think the fellow also realized.
Here is the point I think the fellow was trying to make that I tend to
agree with....Up to a point (and no doubt this point in time can be
calculated), it is better to invest monthly mortgage pay down amounts
and pay down the principal as a large lumpsum later. Ideally, one
should also refinance at that time if prevailing interest rates favor
it.
If for example you are making extra payments of $300 a month to pay
down the principal, wouldn't you be better off investing that $300
each month and paying down the principal with $3600 at the end of the
year instead? Or, does doing it on a monthly basis shorten the loan
more than doing it on a yearly basis?
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Posted by kastnna on April 24, 2008, 2:00 pm
> Here is the point I think the fellow was trying to make that I tend to
> agree with....Up to a point (and no doubt this point in time can be
> calculated), it is better to invest monthly mortgage pay down amounts
> and pay down the principal as a large lumpsum later. Ideally, one
> should also refinance at that time if prevailing interest rates favor
> it.
>
> If for example you are making extra payments of $300 a month to pay
> down the principal, wouldn't you be better off investing that $300
> each month and paying down the principal with $3600 at the end of the
> year instead? Or, does doing it on a monthly basis shorten the loan
> more than doing it on a yearly basis?
It totally depends on the underlying assumptions. If you can attain a
net reutrn on your investment that is greater than or equal to the net
interest rate on your mortgage, then you may be better off investing.
Otherwise, the mortgage prepayment is essentially an investment with a
guaranteed return that matches the net mortgage interest rate.
"Risk" throws a wrench in the works and tends to create a primary
source of disagreement. Most investments that net a return greater
than net mortgage interest rates are not "riskless". Therefore, it's
not really an "apples-to-apples" comparison. It's akin to comparing
treasuries to small-cap value and only considering returns while
ignoring risk.
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Posted by on April 24, 2008, 4:09 pm
> If for example you are making extra payments of $300 a month to pay
> down the principal, wouldn't you be better off investing that $300
> each month and paying down the principal with $3600 at the end of the
> year instead? Or, does doing it on a monthly basis shorten the loan
> more than doing it on a yearly basis?
If you take that $300/mo and invest it - you come out ahead
if and only if that investment itself gains more than the
interest you'd have had to pay on the mortgage. Ignoring
liquidity benefits. So, lets's say you had a mortgage
at 6%, then those 12 payments of $300/ea need to have
grown to something over $3700, actually, by the end of
that year. That first payment has a year to accumulate
interest. That second payment has 11 months to accumulate
interest. etc. etc. If you kept that money in your
checking account earning nothing, then dump it all into
that mortgage at the end of the year, you would definitely
have done better to have prepaid that mortgage monthly -
by exactly that $120 or so that those principal payments
would have saved you in interest.
Every single early principal payment *does* have the
economic benefit of saving you interest that you'd
have otherwise paid. (You're exactly right - monthly
payments don't change - but what those monthly payments
are composed of does - if you prepay your mortgage, then
your payments quickly become more principal and less
interest than they'd been.) But they also have a similar
economic opportunity cost - that money could have been
used for something else. In simple financial terms,
you come out ahead if you use that extra money for the
most productive thing you can. But it's never quite
as simple as all that, since (a) it's generally pretty
hard to get a return on that cash invested otherwise
which is going to beat your mortgage *risklessly*; and
(b) liquidity is a bit harder to put a value on - if
you've used the cash to pay down your mortgage, you no
longer have easy access to it - if you accumulate that
cash elsewhere and then, say, lose your job, you can
use that accumulated cash to keep paying your mortgage
for a while. You absolutely pay a price for that
liquidity - but that price may be cheap next to the
value of that liquidity.
--
Plain Bread alone for e-mail, thanks. The rest gets trashed.
No HTML in E-Mail! -- http://www.expita.com/nomime.html
Are you posting responses that are easy for others to follow?
http://www.greenend.org.uk/rjk/2000/06/14/quoting
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Posted by Augustine on April 24, 2008, 5:53 pm
Why not doing both, say $150 added to the monthly payment and $150
deposited in a MM account, withdrawn yearly to be added to the last
mortgage payment of the year?
HTH
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to keep the conversations on-topic for financial planning. Other posting
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Posted by kastnna on April 25, 2008, 10:25 am
> Why not doing both, say $150 added to the monthly payment and $150
> deposited in a MM account, withdrawn yearly to be added to the last
> mortgage payment of the year?
>
It would be a method of diversifying away the uncertainty of liquidity
and market risk but it also guarantees that 50% of your money is not
being used most efficiently. It's like betting on two different horses
to win the same race. You increase your chances of success, but only
one bet can "win".
Then again, I'm a "risk manager" not a "dollar maximizer" so I
personally like this suggestion.
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Misc.invest.financial-plan is a moderated newsgroup where Moderators strive
to keep the conversations on-topic for financial planning. Other posting
guidelines include a request for brevity and another for trimming posts to
which we respond. For all of the other tips and suggestions, see "FROM THE
MODERATORS: Posting to misc.invest.financial-plan", a weekly post now on the
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