Financial Advice - Rob Peter to Pay Paul!

[SuperK]

So me, being a homeowner for a couple years now, have been crunching some numbers to see what the best finanical gains are for paying my mortgage and building equity the fastest.

I'm paying a total of 89k in interest with no prepayments

150/month is 33k in prepayments. This also saves me 31k in interest. Free money, right? Yes. Is there a better way?

Well I'm still early in my mortgage, so let's play with some other numbers...

I can get a 3 year loan of 5k for 156/month, including 8% interest. Let's take that 5k and dump it directly into my principle. so I'm paying the minimum possible on the mortgage, and an additional 156 in my loan.

Currently I have 5.5k in prepayments, BUT! I have now saved 11k in interest immediately.
3 years later I have paid off my loan. Let's take out that same loan and apply it again to the mortgage.
I now have 11k in prepaiments, but now have saved 20k in interest.

That second payment net me a savings of 9k. There is a bit of diminishing return going on here. Let's do a third loan in the next three years:

I have 16.5k in prepayments, and have saved 26k in interest. I have paid 15.5k less than my monthly payment schedule. that's the same as saving 41.5k on a monthly payment schedule, which is about the same as paying 230/month for 15 years! Except you're not dishing out the 42k in extra payments to net that savings. Whew!
And all these calculations are based AFTER the interest I've paid on my loan as well.



I could continue this but each subsequent payment yields even more and more diminishing returns on the interest saved. The next payment would net a savings of about 3.5k, then 2k, etc etc. But by that time each monthly mortgage payment would yield a hefty part of the principle to begin with so there may be alternate methods that could be beneficial when you're not yielding that good of a return on your loans.

So guys, it IS worth it to rob peter to pay paul!

[Ryan]

yay for time value of money.

[wytbishop]

ECON 208...those were magical times.

[Josh]

Nice! well put. I know my spending habits were on target for something

Since I sold my house 3 years ago I have since decided to pay cash for the next one, or at least a large sum of it. I will continue to save and rent, unless I come across a killer deal. But housing in Seattle is like 200% higher than the national average for a home.

[Daninski]

Returns on making additional payments on your mortgage is fine but it's not considered the best return on your money. The stock market is the only vehicle that has consistently out performed inflation since 1929. Paying bi weekly is of course much better than paying monthly however,,,your saying a loan is @ 8% interest,,ouch. Whats the interest on your mortgage? Mines 3.69% and my line of credit is only 1% above prime.
Consider this, companies offer interest free loans,,,yes interest free loans that you can take for like 3 years. You could borrow from them and dump that on your mortgage. At the end of the 3 years you either saved enough to pay them back or you borrow again from someone else and continue on. Anyway unless you can borrow at a lower interest rate than your mortgage borrowing would be less advantageous than simply making addition payments on your mortgage or shortening the amortization period. Anyway, what the hell do I know.

[SuperK]

8% interest on the 5k loan. My interest on my mortgage is 4.75%. I would pay like 5470 for 3 year loan for 5k. the 8% interest was included in my estimation. The reason why it works is because of how the compounding interest works on the mortgage. This is a risk-free investment. Stock market... not so much.

And no, no one is going to give you a 5k loan interest free.

[SuperK]

Here's something else cool I learned!
So I am looking at making a car purchase tomorrow, at 9,500 asking price. let's say 10k to be a little easier to work numbers with. I *CAN* pay cash but I would like to find a way to make each dollar count the most! Let's crunch some numbers!

So I will sell my current car for 5k tomorrow. I am also preapproved for a 60 month loan for 3.75% APR with 20% down. I considered just dumping the 5k as a down payment since that was money I just gained, and put it towards a new car, BUUUT! Let's see what we can do! With a down payment of 2k, that leaves me with 3k I can invest somehow... but where?


THE HOUSE!!!

In 5 years with no prepayments, my house principle balance will be:
$103,429.97


If I take the 3k and put it towards the principle balance now, the new principle balance is:

$99,627.58

at 2k down, I wold pay a total on my car loan 10,796.60

Interest spent on car: 800
Interest Saved on home:802.97

that's like 0% APR! Hmmm!

What if I don't do a down payment? I could do 5k toward the house instead!
5000 down
5 year Principle Balance: $97,092.58

0 down, total of 11,131.20 paid with interest on the car after duration of loan

Interest spent on car: 1,131
Interest saved on home:1337

Aww, I made 200 dollars! That's neat...

So after the 5 year loan it's pretty much same-as-cash payment with the interest saved on the house. But after that term is completed, since i have lowered my principle balance, I still get even more returns throughout the duration of my mortgage term!

At 3k Down:
Interest Saved: $7,237.01
Total Reduction in Term: 2 Year(s) 7 Month(s)

At 5k Down:
Interest Saved: $11,719.58
Total Reduction in Term: 3 Year(s) 5 Month(s)

How neat! at 5k down the car more than pays for itself after the term is over! But wait... I said...

"I can pay in cash"

so that means I could just fork over 10k to the dealer. What if I just dumped all 10k into the home? NUMBERS TIME!

10000 down
5 year Principle: $90,755.19

Interest spent on car: 1,131
Interest saved on home: 2674.78

Interest Saved: $21,874.29
Total Reduction in Term: 5 Year(s) 5 Month(s)

1500 savings after the car loan term, AND check out the mortgage term savings/reduction! AND I end up with a cool car!

[wytbishop]

As a general rule anytime you can reduce the principle on your mortgage you're going to get the biggest bang for your buck...because it involves the most bucks over the longest ammortization period.

So all that makes complete sense.

[mikeinaus]

duh... are you an accountant or something? i know who im going to talk to if and when i can afford a house

[Daninski]

And no, no one is going to give you a 5k loan interest free.

Well I can't speak for the good ole US of A but there are interest free loans in Canada. I was going to take one out last year and my buddy has borrowed twice like that in the last five years. Catch is they hope at the end of the loan period you haven't paid it back. That's when they make they're money.

[SuperK]

There is same-as-cash financing wich offers 0% APR for certain items, such as furniture and home improvement stuffs, but beyond that, there isn't a unsecured loan that you can get where you get 0% off. I don't live in a cabin by a frozen lake though so things may be different there.

[Daninski]

There is same-as-cash financing wich offers 0% APR for certain items, such as furniture and home improvement stuffs, but beyond that, there isn't a unsecured loan that you can get where you get 0% off. I don't live in a cabin by a frozen lake though so things may be different there.

Kris, with no mal intent,,fook you, I'd take frozen over tornados any day.

[onlytrueromeo]

Call me silly, but I am not seeing this here.

Unless the $5,000 loan has an interest rate lower than the mortgage, you will not save money. Also, there are generally extra fees associated with opening new lines of credit.

Reducing the principle is definitely a great way to plan for the future. As others have said, it is NOT the best ROI, but is a great way to increase your equity. Obviously, reducing your principle NOW is great - but by taking a 5k loan, you are just shifting debt to a different, less protected loan.

Take a $100,000 Mortgage @ 4%. A 30 year loan period would give us $477.44 / month payment. Total of almost $72,000 in interest over the life of the loan.

Now make a balloon payment, of 5k.

$95,000 @ 4% - $453.54/mo, and $68,276 in interest. You have reduced your interest! But...not by 5k. You also need to pay back that 5k, at a higher interest rate.

So, 5k loan, 8% interest, 3yr repayment. $156.68/mo, total of $640.55 in interest.

So, lets add this to the mortgage, where you "saved" money. $640.55 + $68,276 = $68,916. If, as you say, there are diminishing returns - this "reduction" will slow with each pass.


Now, adding a 5k loan increased your monthly payment by $150. If we instead apply this $150/mo to the mortgage...We can shrink the interest paid down to $42,865 and reduce the mortgage period to 19 years in the process. THIS is the recommended strategy to pay down the mortgage early. There are inherent tax benefits to mortgages - not so to other loans. You can also refinance a home - not so with personal loans.

Now if you instead take that $150 a month, invest it in something that will average 4%/yr over 19 years - You will have EARNED $17,000 in interest. And the mortgage would still be under repayment. In this example, it would have been better to apply that extra principle to the mortgage. If you increased your interest rate to 6%, your interest almost doubles to be $30,000. In this case, you come out ahead of the mortgage.

See, not so simple! But I would NOT take out a personal loan to pay off mortgage.

[SuperK]

Romeo, I understand what you're talking about, but your example isn't the same as mine. Mine is a 4.75% interest with a higher principle balance @ 30 years. yours is a lower interest rate, and a lower principle balance.

And I explained the difference between adding a monthly sum rather than a 5 year lump sum. You do reduce your principle balance because you're continually adding 150/month for the duration of 19 years. the 5 year lump sum, I can save the same amount of interest while investing a lower amount towards my principle. See, the thing is, every month, for example, let's say you put in 20% principle, 80% interest. Every month you put money towards your principle, the ratio changes, 22% principle, 78% interest, 30% principle, 70% interest.

a set amount monthly will reduce, say, the principle balance from 20:80 to for example 30:70 at the end of say 5 years.
A one time large lump sum will change teh 20/30 to 30/70 immediately, and after those five years are over, you will have a more even principle/interest ratio, 35/65 or something like that. I explained the difference between making monthly payments and lump sum payments here:

I have 16.5k in prepayments, and have saved 26k in interest. I have paid 15.5k less than my monthly payment schedule. that's the same as saving 41.5k on a monthly payment schedule, which is about the same as paying 230/month for 15 years!

When lump-sum payments don't yield the desired results, I COULD start doing monthly payments to finish paying the mortgage. With my interest rates and priniciple balance and amorization period, every dollar I put in TODAY saves me 2 dollars in interest.


I know you see how it works, but you're skewing the results by changing the variables so the numbers say what you want them to say. Use my numbers, do your math, and you'll figure out what I'm saying.

[SuperK]

Kris, with no mal intent,,fook you, I'd take frozen over tornados any day.

Sigh... I would too... I would love to see this "frozen over tornado" you speak of. I think it would look really cool.