I understand how amortization works basically. I borrow $100,000, over 15 yrs, and the bank sets the payments such that I make equal payments. Initially those payments are mostly interest, until the last which is mostly principle. (Right so far?)
So, let’s pretend I’ve paid off $70k, still owe $30k. But I come into a windfall and am considering putting $25k onto the mortgage, (which I am entitled to do, half before June, mtg anniversary, and half after!)
So, help me to understand, AM I saving lots of interest? Or not? I’ve passed the point where my payments are heavily weighted with interest, I believe.
If I’ve already paid most of the interest, in the earlier years of my mortgage, how am I realizing any savings by paying it down now? How much interest will I save at say 4%?
I’m a little confused, and would really appreciate some education!
There are plenty of amortization calculators on the web that will help you answer the question in your case, such that you can input your specific numbers and get very good estimates of how much in interest payments you will save if you’ve paid off 70% of the principal of your loan.
Here is one. Input your numbers, then click amortization table. In rough numbers, on a 30 year loan, if you’ve paid off 70% of your principal, you’re 80% of the way through your loan term, and you’ve paid about 95% of your interest. Whether that’s a good deal for you is a matter of your own circumstances.
elbows, think of it like you have $30k of the bank’s money, and every month they add to it due to a set interest rate, and subtract from it by your payment. Let’s say the annual rate is 6% to make the numbers easy. Every month they tack on 1/2% and subtract your payment, so this month they’ll add $150 interest and subtract your $500 payment, so that next month they do this same calculation again, except with $29,650.
If you make a $25k payment now, then the outstanding balance will be $5k. Then next month they’ll tack on $25 in interest and subtract your $500 payment, so that the following month the balance will be $4575.
Does that make sense? The mortgate is a contract that they’ll give you a chunk of money and you’ll make monthly payments of at least the specified amount, which they know how to calculate so that it comes out even at the end. But once it gets going, it’s done month-to-month where they add interest to the balance and subtract your payment.
Sorry, I cannot figure out how to use a mortgage calculator to figure if I’m going to save much interest with my $25K payment, to be honest.
Also, “Whether that’s a good deal for you is a matter of your own circumstances.”, seems to mean that, “…paid off 70% principal, 80% through the loan term, paid 95% of your interest.”, must indicate something to you. I’m unsure what it’s supposed to indicate to me however. Sort of why I’m seeking some clarity.
And I understand how my $25k payment will shift my payments, concerning principal/interest split.
What I’m trying to determine is will I realise much savings of interest this late in my mortgage? Or will I just be paying pricipal down early, with little actual savings of interest? Because the bank already got 95%, or whatever, of the interest already?
Forgive me, but clearly I am especially dense in this regard!
Go to that mortgage calculator. Input the amount of your loan (in your example, $100k) and your interest rate (you said 4%). I assume this is a 30 year fixed mortgage, right? You can change that if needed. Enter your start date (roughly) and click calculate.
You should see your monthly payment (principal and interest only – if you have insurance and taxes wrapped up in your payment, this does not include those figures), how much in payments the loan will cost at completion, some graphs and other things.
Near the top, there is a tab labelled amortization schedule. Click it. You will see a year-by-year chart of the cumulative total of how much you have paid in principal and interest.
If you input the start date of your loan correctly, look at the line with 2017. In your example, it should say that you have paid somewhere around $70,000 in principal from the start of your loan to this year. Does that match your understanding of how much you’ve paid off?
Right next to the amount you’ve paid off in principal is how much you’ve paid in interest. On this $100,000 loan example you’ve proposed, it should say something like you’ve paid $70,000 (plus or minus a few grand) in principal and $68,000 (plus or minus a few grand) in interest.
Now look at the very last column in the interest paid column – it should show a figure just under $72,000. This is how much interest you would pay if you just followed your payment schedule for the rest of the life of the loan.
Subtract $68k from $72k, which means for however many years you have left on your loan, if you paid off the entire amount today, you’d save $4,000 in interest payments. (I know you’re not paying off the whole thing today, I’m trying to make this simple.)
Is owning your house free and clear and saving roughly $4,000 in interest payments worth it to you?
I can’t answer that question. You should think about the stability of your job, your current and expected income levels, how much you have saved for retirement, and similar factors as to whether it is worth it to pay off your house.
It depends on the interest rate but running a few simulations in Excel it is roughly $500 x the interest rate. e.g. 4% => about $2250; 6% => about $3000. And you take 3 years off your terms.
Your basic spreadsheet program will have the basic financial functions to calculate all these scenarios … I just wanted to put Ravenman’s numbers into terms of actual value … the interest you’d save is equal to a pizza-pie per week for almost four solid years … enjoy …
I ran some basic numbers assuming a 4% interest rate, when you had $30K left on the loan you had 5 years left on it, and that even after dropping the $25K down you would still take 5 years to pay off the last $5K.
If you did nothing for those last 5 years and continued to pay off the $30K loan you would pay $3,150 in interest.
If you plunked down that $25K dropping the loan to $5K and took 5 years to pay it off you would pay $525 in interest.
Savings of $2,625.
Thanks for all your help. It has made some things much clearer for me. You’ve given me a lot to think about.
Hampshire, why would I take five years to pay the last $5K ? That part confuses me a little. How much difference would paying that off in one year make in those numbers?
I place a pretty high value on my hubby being free of this monthly payment, and the stress that comes with it. Our finances are stable, it’s not made us much where it currently is anyway. Nothing’s been decided, and our investment dude hasn’t weighed in yet. But thanks you for helping me to understand this better, I appreciate your patience very much.
Another way to look at it - what’s your interest rate? 4%? 6%?
Is there any investment you know of that guarantees that rate of return? (Market mutual funds can be a crapshoot - up or down, who knows) So if you put the money into your mortgage, then in a year or two when you’ve paid off the mortgage, put the equivalent of mortgage payments into whatever savings tickles your fancy… Now you are living rent-free and saving for retirement.
As an aside, you can calculate these values in Excel using the PMT function. That allows you flexibility to isolate any of the components you are interested in.
When we were paying down our mortgage, there was a checkbox on the slip to denote that the extra payment was going towards the principal. Otherwise they would count the extra as merely an early payment. (I.e., they have your money interest free. The length of the mortgage and total owed doesn’t change.)
I understand that there are some mortgages out there that have a penalty for early pay-off.
I don’t think it’s necessary actually to use a mortgage calculator. As borrower you’d know the interest rate and how long ago you took out the mortgage. Say it was 4%, then with around 4 yrs left there’d be around $30k left outstanding (which I figured out with the Excel PMT function, but again you’d already know the final maturity if you were the borrower).
So it’s like MD2000 said. What can you earn (after tax) on a safe investment with a maturity less than 4 yrs*, as compared to the after tax cost of a 4% mortgage? The two ‘after taxes’ depend on your particular tax situation. But there are not safe investments paying anything like that now in that maturity. So paying back the mortgage is the best ‘risk free’ investment of the money. You can take more risk investing in stocks and assuming/hoping they outpace 4% after tax, which they might or might not. Also some people would need the $25k ready in the bank, to keep or attain adequate liquidity to cope with job loss or unexpected expense, but if a ‘windfall’ it implies that’s not the case.
*to calculate the remaining ‘average life’ you would once again need some calculation. But suffice to say it’s less than 4yrs because it’s amortizing, most accurately compared to a CD or bond fund with a maturity between 2 and 3 yrs, not 4.
You can’t change the interest you’ve paid in the past, so it shouldn’t enter into your decision for what to do now.
Paying off $25k early will mean you don’t pay any more interest on that $25k.
Think of it this way: What if you had taken out a $30k loan (your current principal) the day before you got the windfall, and hadn’t paid any interest yet. In that situation, if you pay off $25k immediately, you’ll save the vast majority of the interest on that loan. That’s the situation you’re in. It doesn’t matter how big the loan once was. What matters is the interest rate you’re paying and what your other options for the money are (if the rate is quite low, you might be better investing the money elsewhere).
Given your acknowledged lack of expertise in this matter, paying down the mortgage is very likely the right move. You’ll have to pay it off sooner or later, and it’s a guaranteed return at whatever your current interest rate is, which is probably quite good.
Yes. That’s kind of the funny thing about amortization. When someone is down to the last 5 years and $30k of their 4% locked 30 year loan they’re thinking “cool, this is the part of the loan where my payments are going towards principal”. While true for the life ot the 30 year loan, those last five years of payments and how the principal vs. interest is divided isn’t any different than if someone took out a brand new 5-year 4% $30K loan.
The main difference is if you took out a loan to buy a car or furniture or install a pool, you’d probably pay a much higher interest than the mortgage is at. That’s because a loan backed by real property that can be sold to recoup the loan is safer than one where they’d have to chase you with garnishee orders. (Plus the mortgage docs say they have first dibs on the money if it comes to a sale)
Still, yes, the rate you are paying is substantially more than a bank or bond company would pay you if you lend them your money…
iamthewalrus is right, you’re looking at it all wrong. Forget the amortization calculators. Only consider the situation you’re now in.
You have this loan with $30k oustanding. You’re paying, what, 5% interest on the money? There’s also a contract still in effect that you have to pay what, $500 per month?
You also have $25k available to you. The proper things to consider are:
What kind of interest rate could you get on the $25k if you invested it, compared to what you’re paying on the bank loan? If you invest it in the stock market, could you make more than the rate you’re paying on the loan? For this comparison, don’t even consider the mortgage interest income tax deduction - you get to deduct interest you pay, but you have to pay tax on the interest/appreciation of the investment, and they pretty much cancel out.
Will you be less stressed if you no longer have that contract to make $500 payments each month?
Is the risk of possibly earning less interest on your investment a consideration for you? You will likely make more by investing it in a good index fund, but it is a little bit of a gamble. You could make less, or even lose money on your investment. In the long term, going with the moderate risk of a stock index fund has always proven to be a good strategy, but you have to be able to tolerate short-term ups and downs.
Getting into calculations of how much interest you’ll avoid over several years is a meaningless exercise. Forget about going down that hole.
You now owe $30,000 at 4%
Discounting monthly payments your yearly interest this year at 4% is $1200
Or $100 this month. and decreasing each month.
You make a payment of $25,000
You now owe $5,000. This years interest at 4% is $200
or $16.67 this month, and decreasing.
Saving you around $83.33 per month.