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Posted by Jeff Strickland on May 6, 2006, 8:03 pm
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>
>>I am now at a point where I would like to send at least 1 extra payment
>> to my mortgage company each year. I know that my loan will be paid off
>> sooner because of this. I have a few questions.
>>
>> 1) I believe sending 1 extra payment will help the loan to be paid off
>> about 6 years sooner. Is it good to send more than 1 payment if
>> possible?
>>
>> 2) My mortgage company allows you to pay extra to either interest or
>> principle. Which is better or should I stick with the current break
>> down as they are requiring me to pay for each year?
>>
>> Thank you.
>>
> Have you considered putting that money in a Roth IRA, instead? It will be
> worth more in the same time frame as paying off your mortgage, and you
> won't lose the tax benefit.
>
> Talk to a financial planner. I know it's a better move.
>
Rainmaker might be correct with his suggestion for the Roth IRA, ask your
tax planner.
To answer the original question, you can ALWAYS pay more than the required
payment, and any extra you pay will always go to reduce principle.
You send in your check and the bank takes the interest first -- they always
want their money before anybody else, or everybody else -- then they hold
out the impounds if any, then they reduce principle with what is left. The
interest due is pretty much the same but it does change over time. The
impounds remain constant from month to month, but might change annually. The
principle amount also is more or less a constant, although it also changes
slowly. In the beginning of the loan term, nearly all of the payment is
interest, and very little is principle (since impounds are defined and are
fixed, we don't need to spend much time on them). Over time, the interest
that is due each month goes down, and the principle that is paid off goes
up. It takes something on the order of 12 years of a 30-year mortgage for
the interest and principle portions of the payment to be equal, and they
remain more or less equal for a few years. Then, the interest due drops off
and the principle that is paid down increases.
Now, back to your original question. Yes, you can add 1/12th to every
payment and make an extra payment each year that way. All of the extra
payments you make go towards repaying principle. There is no benefit to you
to prepay interest, but there is huge benefit to prepaying principle. No
only can you add 1/12th to every payment, but you could double the payments
if you have the financial wherewithall to accomplish such a feat. You can
also simply add an extra $300 each month, or whatever you are comfortable
with. If you'd like to tell me the original loan amount, and the payment you
are expected to pay, I'll tell you the payments you need to make to turn
your loan into a 20- or 15-year note. The beauty of this -- voluntarily
overpaying the note -- is that if you have a financial crisis (the
transmission falls out of your car, or your kid wants gold plated roller
skates for Christmas), then you can simply make a normal payment until the
crisis passes, and the bank won't care.
Is this a better strategy than funding your IRA? I don't know the answer to
that one.
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