Paying back mortgage confusion

fredfrombcDecember 3, 2013

I am a new home owner. I am confuse about over payment on my mortgage. If I pay extra $100 every month, is it going to reduce my interest? A group of friend say no and the other say yes.. please help..

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mxyplx

If you Google > Overpaying My Mortgage

Here is a link that might be useful: overpay

    Bookmark   December 3, 2013 at 11:22AM
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emma

It was explained to me that if you pay an extra $50. on the payment that is $50. off of the principal and you will not have to pay interest on it for the remaining years. Not sure I worded that right but I paid off our last home in 15 years instead of 30 by paying every extra dollar I got my hands on. I worked part time when I was bored and put every pay check on it.

    Bookmark   December 3, 2013 at 4:19PM
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joyfulguy

In the early years of one's mortgage, the remaining debt is high, so most of the payment goes to cover the interest owing at your contracted rate and only a very small amount goes to pay down on the principal.

Next month, the amount still owing will be the amount this month, less the amount of principal that was paid this month ... so the interest owing on that slightly lower amount of principal will be less ... and a slight bit more will be used to reduce the principal.

If you pay an extra $100., that won't be used to pay interest, as that has already been paid. I will all go to reduce the amount of principal owing, so there'll be a smaller principal still owed during the next month, which will result in a slight reduction in the interest payment on that, resulting in a slight increase in the amount of your payment that goes to reduce the principal still owed.

Extra payments, especially in the early years, usually cause a much larger reduction in the principal still owing than the amount of one's payment that goes to reduce the principal, which will hasten the day when the mortgage is fully paid off.

ole joyful

    Bookmark   December 3, 2013 at 4:29PM
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mxyplx

Be sure to inform the lender that the extra money is for Reduction of Principal so there is no mistake of your intent.

    Bookmark   December 3, 2013 at 6:28PM
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emma

msypix, I never did that. Where else would they put it????

    Bookmark   December 4, 2013 at 10:03AM
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dadoes

EmmaR, my last mortgage bank (of three that serviced it along the way) applied the extra amount as a prepayment of the next scheduled payment instead of to the principle with the current payment. Took a couple cycles of messages to get them settled on the situation. I made the mistake on the last payment of not contacting them to confirm the payoff. I remitted the current interest plus the total remaining principle of $5K. They put the entire payment into "suspense" so I had to call them to get that sorted-out as well.

    Bookmark   December 4, 2013 at 11:43AM
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mxyplx

msypix !!! ???

Hmmm. :-)

    Bookmark   December 4, 2013 at 12:02PM
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dadoes

Anyway, to further address the OP's question ... additional payments (if your mortgage contract doesn't prohibit them) absolutely reduce interest.

The amount of the required (monthly) payment doesn't
reduce, it must remain at least the "minimum" contract amount.

Each payment's interest is calculated on the remaining principle, so after an extra principle payment has been made, the next "normal"/calculated monthly payment comes out for a little less interest and a little more of it goes to the principle.

By continuing to add extra to the payment, the principle chips away faster and there are fewer payments ultimately required, and of course less total interest.

I paid-off my mortgage a few months ago, 6-1/2 years early.

Total interest per the full contract term, making the normal required payments, would have been $37,056.01.

By accelerating the principle, I paid only $20.516.67 interest, so saved $16,539.34.

    Bookmark   December 4, 2013 at 12:04PM
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emma

Dadoes I just paid extra and nothing changed so they were putting it where they were suppose to. Thanks for putting your figures in. I never did the math, I just wanted it to be paid off before we retired. I knew I was saving interest and was glad it was the type of loan that let me pay it off earlier. I have heard some loans don't allow that without a penalty.

This post was edited by EmmaR on Wed, Dec 4, 13 at 14:17

    Bookmark   December 4, 2013 at 2:16PM
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fredfrombc

Thanks for all your responses..

Lets continue the conversation..

Another argument is, you benefit more from the year end tax return if you don't pay off early. What is your stand on this statement?

Sorry for lot of questions since first time buyer and don't want to take the wrong turn.

Thanks again..

    Bookmark   December 4, 2013 at 2:56PM
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emma

I am not sure if you are talking about tax deduction or what, that is not important to me. I just wanted my home paid for so I can enjoy my retirement without the worry payments

My neighbor is not going to be able to keep her home when she retires or if her husband should die first or if she loses her job. That is not acceptable to me. She should be putting every dime she has extra and pay it on the house. I would never have bought a home in that situation, I would have stayed in my last home.

I am going to buy another home in 2 or 3 months and with a temp loan I will be able to pay for the new home when mine is sold.

    Bookmark   December 4, 2013 at 4:02PM
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fredfrombc

yeap.. i was talking about tax deduction.. and Thanks for reply

    Bookmark   December 4, 2013 at 4:11PM
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dadoes

Mortgage interest is a deduction against income, not a credit against tax due. It provides only a percentage of the year's interest paid in tax savings. Roughly figure it as the interest paid X the tax bracket. Example, $2,500 interest paid, taxpayer in the 15% bracket, saves $375. Does it make sense to pay $2,500 interest to the mortgage company to save $375 on income tax? Maybe, IF the additional principle that would be paid could be invested to garner enough income to make up the difference. Calculating the numbers gets complicated. The investment income is also subject to income tax, unless the investment is in tax-free bonds or some such.

Of course, larger mortgages, higher interest paid, higher tax brackets changes the numbers accordingly. Depends what is reasonable for the individual.

My state of residence does not have a state income tax. Is mortgage interest deductible on the state level for those that do? Both state and federal?

This is the 2nd time I've paid-off a mortgage, and both were accelerated. The feeling of security and reduction in "mental strain" of carrying the debt is hugely gratifying and is greater this time than the first.

    Bookmark   December 4, 2013 at 5:16PM
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emma

dadeos, The feeling of security and reduction in "mental strain" of carrying the debt is hugely gratifying.

That is exactly how I feel also. When my Mom bought a home they advised her to get a loan instead of paying it off. Back then it was better financially to do that but she wanted it paid for. She had never had anything nice before and paying it off made her feel more secure. It was her dream home.

This post was edited by EmmaR on Wed, Dec 4, 13 at 17:37

    Bookmark   December 4, 2013 at 5:36PM
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mxyplx

If you have a tax program you can plug these questions in and get an answer that fits your situation. This accounts for all your variables and, of course, you can try different scenarios. Once it's set up whenever something comes along plug it in and get your answer immediately.
Even if you hire your taxes done it's an advantage to have a tax program handy just for this stuff. Altho the program may be a year or 2 behind current it still gives you a comparison of alternatives.

And as I have preached for centuries - any economic study MUST be a comparison of alternatives.

    Bookmark   December 5, 2013 at 9:48AM
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fredfrombc

wow.. it would be a lot to plug in while calculating different interest for overpaying. but look like it is only way to go to get a real answer.

    Bookmark   December 5, 2013 at 4:02PM
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mxyplx

HI-

Yes it would be a lot starting from scratch. Use some shortcuts. For example input all bond interest as from one bond; use the standard deduction; or one big item for itemized deductions. Leave personal info out except married or single etc

You needn't be super accurate to make a first comparison to see if a scenario is worth persuing. If it seems worthwhile then nail it down with the bloody details.

    Bookmark   December 5, 2013 at 6:36PM
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MrsShayne

Here's something to remember - If you take a 30 year mortgage and make one extra payment per year, then you'll knock about 5 years off your mortgage. (That's how much interest we pay...)

Another thing to think about - if you have a 30 year mortgage on say a $300,000 home, and 15 years down the road you think you're halfway paid off (owing about $150K) - WRONG - you actually only will own about 25% of the home (again, that's how much you pay in interest). It's called the 50/25 rule.

    Bookmark   January 13, 2014 at 5:30PM
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raee_gw

It is a rare case that having the interest as a tax deduction is more to your advantage than paying less interest overall, I think.

You simply don't get all that money back in tax savings; you only get a little bit of it.

In the long run you are assured to end up with much more money in your pocket by pre-paying your mortgage--by having saved the money instead of spending it on interest.

Yes, it is possible that, if instead of pre-paying the mortgage, you took that money and bought stocks that gain in value you might end up with a greater gain.... until you fail to sell the stocks at just the right time and they lose value again (as stocks tend to do).

I personally did both -- prepaid my mortgage and put some money into the stock market. But if I had to choose, I choose pre-pay the mortgage.

    Bookmark   January 16, 2014 at 8:47PM
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colorcrazy

Fred, for what it is worth, I have an MBA in Accounting, and I agree with the others. The tax savings from having mortgage interest as a tax deduction is small compared to the interest savings when paying a mortgage off early.

Plus, as the others said, it is a good feeling to have the mortgage paid off; gives you much more flexibility. We paid off our 30 year mortgage in 19 years. Now we are able to save a lot more, but we can also relax.

First, you will want to consider building up your savings so that you have three to six months of living expenses saved and have a good start on your IRA, etc. After you have done that, then add to your IRA every January (now for 2014, for example) and then any savings can go to your mortgage.

By now, I hope you know not to listen to your friends who said paying off your mortgage early will not save anything. ;)

    Bookmark   January 19, 2014 at 11:55PM
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joyfulguy

Any bank that says that an extra payment is just paying next month's payment now is scamming you.

They get all of that money free for a month ... cause you don't owe that money to them until a month from now!

If you have $100,000. mortgage at 5%, you owe them $100,000. for only the first month. The interest owed for that month will be 5% of that, or $5,000., divided by 12 if you pay monthly, or by 26 if you pay bi-weekly (which will pay it off more quickly, there being a couple of extra payments per year).

On monthly pay, your debt would be 5,000. divided by 12, or $466.67. I don't know the amortization figure that would mean that, on a 25 year mortgage, you'd have all of the debt paid in full by paying the same amount, month by month, throughout that 25 years. Suppose it might be $500.00 ... which would mean that, having paid the interest of that $416.67 on the $100,000. mortgage, there's $83.33 left from that payment to pay down the principal ... which becomes the new amount of $100,000. - $83.33, or $99,916.67. The interest owing on that amount for the second month will $416.31945, or $416.32, leaving $83.68 to pay down the principal. In the third month, with $99,832.99 still owing, the interest cost will be ...

Sorry - my calculator just quit, and can`t make the one on the computer do what I want it to ... and the library is closing in 10 minutes.

Another reason, apart from the price of gas and time ... to get my home computer hitched to the public!

You can see how, as the interest to be paid on the remaining principal drops month by month, the amount of principal that gets repaid monthly grows.

If you can make one extra payment per year, to reduce the principal owing by all of that amount, it could well be as much or close to it as your monthly payments had reduced that principal through the whole year.

Good wishes for making a good mortgage.

ole joyful

    Bookmark   January 27, 2014 at 3:55PM
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