Paying additional On Your Home Mortgage
Often times mortgage brokers and mortgage bankers promote products or ideas to the consumer that aren’t always in the borrower’s best interest. There are already whole companies that thrive on these concepts and the trouble is that often the proposal sounds great on the surface but if you truly understand the implications it turns out to be a poor and already questionable idea.
One of these concepts is to make additional payments towards your mortgage, over and above what you are committed to pay. This is typically done one of two ways. Some companies want you to pay one half of your mortgage payment every two weeks (instead of the complete mortgage payment once a month as your are contracted to do) and others want you to pay an additional amount towards your mortgage payment each pay period. This might be $100 to $200 or more which is to be applied to your rule.
They promote this as a way of paying off your mortgage early and thereby saving you 1,000’s of dollars in interest. Is this true? Yes, it is if you look only at the surface of what they are asking you to do. Let’s take a look at what it accomplishes, what might be a better different an example of what happens with both.
It’s important to understand that when you take out a 30-year fixed rate mortgage, your payments of rule and interest is SET for the next 30 years – 360 payments. Every payment received only goes toward the current rule and interest due. The payment of additional monies toward the loan don’t go towards re-amortizing the loan but only is applied to the rule due at the end of the loan. basically, if you paid an additional $30,000 towards your mortgage then you would have your mortgage paid off once your amortization schedule reached the point where you only owed $30,000.
They indicate that you’re saving all this interest only because you do pay your loan off early. Now, here’s the but. The additional payments you make is money out of your pocket (thereby not working for you) and additional monies in someone else’s pocket. And, many of these companies already charge you a fee for this service. How dare they!
You could accomplish the same goal by setting up a savings account and putting that same amount of money in the account each pay period and truly pay the loan off already earlier because you would have compounding interest to help grow your deposits. Or, you could take that same amount of money that you are paying out each month and apply that to an IRA or a 401(k) or to a child’s college savings plan and those investments might already grow at a faster speed than just being in a savings account.
Here’s an example of what I’m talking about. Let’s assume you take out a $100,000 30-year fixed rate mortgage with a 5% interest rate. Your rule and interest payment would be $536.82. If you paid an additional $100 a month, you would have accumulated an additional $30,000 in approximately 25 years and would be able to pay off your existing mortgage, which would only have $30,000 left in rule. If you paid and additional $200 a month, you would have accumulated an additional $50,400 in approximately 21 years and would be able to pay off your existing mortgage.
If you had taken those same additional payments and invested them such that they earned 4% yearly, at the end of 25 years your $100 a month additional payment would have grown to approximately $51,800 and your $200 a month additional payment would have grown to approximately $79,500 by the end of 21 years. With the first scenario, you could nevertheless pay off your existing mortgage but would have an additional $21,800 left over. In the second scenario, you could again pay off your existing mortgage and would have $29,100 left over.
These companies aren’t providing you with any real service and at the same time are making money off the payments you contribute and already charging you for this. It makes no sense.