Will76... financial question
 

Since you seem to be on the ball with finances and money, I'm questioning what my accountant told me (and this does not mean I need a new accountant).

I have a 30 year mortgage at 5.125%. If I pay an additional $94/mo it will get paid off 4 years and 1 month sooner. $194/mo will get paid 7 years 5 months sooner.

Personally, I think it would be best to pay it off quicker, no? I don't plan to live in this place until I die, most likely selling it in 7 or so years to move to a bigger place so I'd want to have as much equity as possible.

However, my accountant told me in doing so, I loose interest that I can claim each year, but I don't think that really matters unless I plan to live here for the next 29.5 years right?

Don't think of this as paying it off sooner, you need to look at it as if I pay "X" number of years it will cost me "x" in interest payments. You have to pay principle no matter how long or slow you pay it back, you still going to pay 100% of principle. However, you can control how much damage they bank will do to you by charging you interest. You can control how much you will pay in interest by adjusting the length of time you borrowing the money and paying it off.

"loosing interest" that you can claim for taxes isn't a bad thing, because it means you paying less in interest. You don't want to pay more money in interest payments just to get write offs. An accountant is wired to think on how to help you reduce your tax burden, not help you save,invest, make money.

Being able to use the tax deduction is a benefit to owning a home (vs renting) but not a reason to paying tons of money in financing if you don't have to.

I would do this, go to http://calculators.interest.com/cont...ly-payment.asp and play with the numbers. Put in the loan amount and interest rate you paying. Try it at 30 years and make sure it confirms what you paying now so you know you got it right. Then put in 25 years, 20 years and look at the monthly payment. Also click "Show Amortization Table". This will show you how much you pay back in interest depending on how many years it takes you to pay off the mortgage.

200K - 30 year mortgage at 5.125% = monthly payment: $1089 total interest paid: $192,252

200K - 25 year mortgage at 5.125% = monthly payment: $1184 total interest paid: $155,313

200K - 20 year mortgage at 5.125% = monthly payment: $1334 total interest paid: $120,235

It comes down to this... how much are you comfortable a month paying. In the example above if you can swing $1334 a month vs $1089 you will save 72K over the next 20 years in interest payments.

99% of the time it is not wise to spend money just to get a tax DEDUCTION. Send me $1 I will give you .25 cents back ;) You would be better off not spending the $1. Now tax CREDITS are a different story.

The other thing to take into account since your interest rate is pretty low is.... do you feel confident that you can take that extra money and make more than about 8% return with it ? If you can then pay the min a month and invest the difference. If not, the safest and easiest thing to do is pay as much as you feel safe doing each month, save a ton on interest payments, and build equity in your house faster. If you need a loan in 5 years you will be able to get a HELOC if you been paying it off on a 20 year amort schedule, vs a 30 year. 5 years in on a 30 year repayment schedule you will have very little principle built up and likely wont be able to get a loan unless the value of your house shot up a lot.

Accountants are rarely the best people for financial advice, they look at things in the past mainly, and only look at one component, how to save you taxes and not a holistic approach taking everything into consideration.

On a 30 yr note: If you make one extra payment a year you reduce it to a 15 yr note.

that doesn't sound right. Can you explain more or a link to info to show how they figure that.

So if I am paying 2,000 a month on a 30 year mortgage. (24,000 a year) you telling me if I pay a total of $26,000 a year instead I only have to pay for 15 years instead of 30 ?

You mean one extra payment per month and not year.

recommend googling financial calculator

Certain interest paid is an expense, albeit a tax subsidized one (for now). Remember, most tax delectable expenses are the result of some cost you actually paid.

No, one extra payment per year it turns it into a 17 year note.

What calculator are you getting this from? You already changed your time range right in this thread.

And is that one extra payment per year, or is that one extra payment spread out through your other 12 payments totaling one payment?

A mortgage underwriter once told me the best way to pay your mortgage is 2 times a month Half on the 15th and half on the 30th.

Must be Rochard math. It was 15 years now its 17 years. I already asked you once to provide a source or to please explain. What you saying doesn't add up to me.

I haven't looked into that a whole lot. I've heard a few people talk about what you are saying and there was people trying to sell "systems to do something like this" etc.. but at the same time you need to check to see if your mortgage company allows you do these things. It was a while back and I vaguely remember, I just know what ever the trick was my particular company wouldn't let me do it.

Another tip for you guys before you go to do your next mortgage... if you didn't already know, the break points for a reduction of interest is at 15 years. There is a 30 year rate and a 15 year rate which is usually good bit less. So if you are positive you can afford it and you want to pay it quicker / less in interest, then do it over 15 years and benefit from the interest rate reduction.

However, if that amount per amount makes you nervous and you worried that over 15 years you might not be able to afford it, then don't do your loan for 20 years or 25 years, jump all the way to 30 years because the interest rate will be the same at 30yrs as it is from 16yrs-29 yrs. So you would be best off doing it at 30yrs, and sending in additional principle each month that you can afford to and if your financial situation gets bad at some point you stop sending the extra. (double check with your bank, but every one I've dealt with and everything I have heard this is the case.)

Yep.......

The math works out but most places don't seem to allow you to do that.

I think it falls between 15 to 17 years. This is real estate 100. I'm not wasting my time proving this. If you want to learn YOU will google it. I have my real estate license and like I said, this is real estate 100.

Mortgage is nothing more than a loan, you borrow certain amount at certain interest rate.. the rest, 15 years, vs 30, vs prepaying, etc is all just a smoke screen it makes no difference...

All you need to know is that:
1. you have lets say $200k loan at 5.125% interest rate
2. interest is tax deductible

What this means is that if you are in 25% marginal tax rate bracket, then the effective rate is more like 3.8%*

so then, if you can make more than 3.8%/year by investing in your business or stocks or whatever then you shouldn't prepay...
if you can't, then you are better off prepaying..

*(exact details may vary depending on your situation)

So you can't explain it then... thanks for sharing. How hard would it be to explain it to us and tell us how it works???

15 years vs 30 years is smoke screen that makes no difference? You do know if you do a 15 year mortgage the interest rates are a good bit less than if you did a 30 year mortgage.

I'm cool and I used the Google. Looks like you would save six years, not 13 or 15. There is even math.

http://www.mortgagecalculatorsplus.c...r-mortgage.php

Hopefully, this guy knows more about mortgages and math than being a real estate agent.

I was looking for an answer more like this:

The basic formula for calculating mortgage interest is:

Monthly Payment = Principal [ i(1 + i)n ] / [ (1 + i)n - 1]

which is explained in depth with detailed examples in the ebook. The "i" in the formula is the interest per compounding period, or the annual interest divided by the number of payments per year. It works out to this because mortgages are structured so that the payments are made per compounding period, normally a month, which makes it easy to produce a meaningful amortization table. The "n" in the formula is the number of compounding periods in the life of the loan. For a normal 30 year mortgage, n=360.

So you go to a bank and get approved for a 15 year or a 30 year fixed rate mortgage, and then you decide you want to pay it down a little more quickly by making 13 payments a year. The banks aren't normally set up to take a payment every 4 weeks, so the normal way to go about it, assuming again no penalties or fees, is to add one twelfth to each of your monthly payments. The question then becomes, how much time will you shave off the mortgage? The answer is, it depends on the interest rate, which will be a known for the mortgage you are accelerating, as will the principal and the period. So if you start prepaying at the very beginning of the loan, the formula can be simplified so we can solve for n, the number of payments. We'll substitute "x" for the messy part of the equation as we move things around, so it reads,

M(onthly payment) = P(rincipal) [ix / (x-1)]

multiply both sides by (x-1)

Mx - M = Pix

divide by the monthly payment

x-1 = Pix/M

divide both by x

1-1/x = Pi/M

rearrange

1-Pi/M = 1/x

and invert

x = 1 / (1-Pi/M)

substitute back in for x
(1 + i)n = 1 / (1-Pi/M)

which we might have reached faster if I was smarter about it, but that's as close to n as we're getting.

Now let's take some real numbers, like one of the examples from the ebook with a 30 year mortgage at 4.5% for $187,000 with a computed monthly payment of $947.51. If we were able to make 13 payments a year, we would use 13 compounding periods for:

i=0.045/13 = .003462

1+i = 1.003462

(1.003462)n = 1/[1-$187,000(.003462)/$947.51]

(1.003462)n = 1/(1-.6833) = 1/0.3167 = 3.16

So to solve for the amount of time lopped off the mortgage, we need to find an "n" that make

1.003462n = 3.16

The way to do this is to take a few guesses, let's start with 300 four week "months", and use the ^ for "to the power of"

1.003462 ^ 300 = 2.82, way too low, so let's try 312 "months"

1.003462 ^ 312 = 2.94, still too low, so let;s try 324 "months"

1.003462 ^ 324 = 3.06 getting close, so lets try 336 "months"

1.003462 ^ 336 = 3.19, too high, so try 333 "months"

1.003462 ^ 336 = 3.161, so that's what we're going with.

333 four week "months" has to be divided by 13 to see how many normal 12 month years we get

333/13 = 25.62 years.

Of course, it's not easy to find a bank that operates on 13 month years, but the difference between actually compounding 13 times a year and compounding 12 times a year with an extra /12 on each payment or a bi-weekly payment of $947.51 divided by two for the equivalent of 13 weekly payments will all come out around the same. It's easy enough to check the 12 payments with extra twelfths using the standard mortgage formula. Instead of

$947.51 per month, we'll pay $78.96 + $947.51 = $1026.47 per month giving:

i=0.045/12 = .00375

1+i = 1.00375

(1.00375)n = 1/[1-$187,000(.00375)/$1026.47]

(1.00375)n = 1/(1-.683) = 1/0.3168= 3.16 (notice that the 3.16 is the same factor we arrived at using the smaller payment and 13 four week "months"

We know the answer we expect to see is 25.62 years, so lets compute our first guess at n from 12 months times 25.62 years:

12 x 25.62 = 307.44

1.00375 ^ 307.44 = 3.16

So unless I made a math error somewhere, prepaying a the 1/12 extra payment each month is equivalent to making the payment 13 times a year. Now let's check bi-weekly for the same mortgage principal, using half the monthly payment on the 30 yr as the bi-weekly payment. Note that the interest being compunded bi-weekly means dividing the annual interest rate by 26:

$947.51 per month, we'll pay $947.51/2 = $473.76 per month giving:

i=0.045/26 = .001731

1+i = 1.001731

(1.001731)n = 1/[1-$187,000(.001731)/$473.76]

(1.001731)n = 1/(1-.683) = 1/0.31675 = 3.16 (notice that the 3.16 is the same factor we arrived at using the smaller payment and 13 four week "months" and the higher payment 12 times a year to the hundreds place, though there was a small difference, ie, 1 / 0.3168 vs 1/0.3156.

We know the answer we expect to see is 25.62 years, so lets compute our first guess at n from 26 biweekly payments times 25.62 years:

26 x 25.62 = 666.12

1.001731 ^ 666.12 = 3.16

The main point is that the savings in time and interest are all relative to a 30 year mortgage that you would have paid off otherwise. There's no winning or losing here. Taking out a 30 year mortgage that allows you to prepay and making the equivalent of 13 payments a year will cut around five years off the mortgage, but those payments are no different than if you had taken out a 25 year mortgage to start with. The math is the same. The bi-weekly mortgages don't offer any savings over adding to the monthly payment, they were simply set up to help people who were bad at saving to manage their money. Since many salary employees get paid every two weeks, a the bank could automatically debit their checking account biweekly for the mortgage amount, and may insist on your enrolling in automatic payroll deposit to set up the loan. The only equivalency between bi-weekly and 13 payment mortgage schemes and paying off your mortgage "early" is if you arrange them so as to pay more on an annual basis than you would have done with a 30 year mortgage, as we did above.

I meant given same interest rate, it makes no difference if you pay it off in 5 years, 15, 30 or 100 years... obviously if you are getting lower interest rate than it does make a difference...

in bossku69's situation the interest rate is fixed, the only question is if it makes sense to prepay...

Exactly. And it matches up to what I posted in my original post:

200K - 30 year mortgage at 5.125% = monthly payment: $1089 total interest paid: $192,252

200K - 25 year mortgage at 5.125% = monthly payment: $1184 total interest paid: $155,313

200K - 20 year mortgage at 5.125% = monthly payment: $1334 total interest paid: $120,235

If he was to amortize his loan at 25 years (in the example above) it would cause him to pay about $100 more a month, which equates to about 1 extra payment a year. In that case, if he paid the extra each month would mean he would pay it off in 25 years instead of 30.... reducing it by 5 years.

It is easy to use the calculator on the link i posted and just plug in how much a month, and let it show you exactly how much you pay each month and more importantly how much you save in interest. Since interest is compounded the quicker you pay it off the less you pay.

I doubt Mr. Real-estate license will come back in with proof to explain this he is obviously confusing this with something else. Any idiot can get a real estate license, I know I passed that test to get one years ago lol.

Getting back to the tax savings/reductions/credits ...

You will also want to remember that when you sell your home, Uncle Sam wants every penny of that back ... this is often overlooked, and is a shock to a lot of homeowners who sell their homes.

are you sure about that? "depreciation" you have to pay back... paying back interest deductions is news to me... link to source?

No, he can't be sure about that, one thing you'll find in here is that Canadians love to comment on US laws and politics, but seem to be wrong 90% of the time. Thanks to the Taxpayer Relief Act of 1997, many home sellers no longer owe taxes on the gain they make when they sell their houses. Married taxpayers who file jointly now get to keep, tax-free, up to $500,000 in gain on the sale of their home, as long as they lived in it for two of the prior five years. Single folks and married taxpayers who file separately get to keep up to $250,000.

Looks like you need to go back to Real Estate 100 and re take the class. Depending on a few variables, making 1 extra mortgage payment annually will reduce your 30 yr fixed mortgage by 5-7 years.

Hmmmmm, we aren't allowed to give out expert advice to things not pertaining to real estate. LOL

Are you guys calculating 20% down payment with one extra payment a month?

What does a 20% down payment have to do with a $200,000 loan? A $200,000 loan is a $200,000 loan. It doesn't matter what you paid on top of that as a down payment.

If your house was $200,000, you put down a 20% down payment of $40,000, you would then effectively have a $160,000 loan (assuming you did not add on another $40,000 to the loan just for the hell of it), not a $200,000 loan.

Yes, I agree. You are correct, I'm trying to understand myself. Like I said I've read this before and have been told this by many people/instructors. It's the same principle as the make a payment every two weeks. You are only adding one additional payment a year which reduces the principle.

Anyway, the answer the org question should be.

If you can make more money at a higher rate than your mortgage rate, then don't pay down your note.

Right not sure what he is talking about either. Mortgage payment interest is tax deductible if it is your primary residence and a few other situations, i've never heard of someone having to reclaim the deduction when they sell their house. Depreciation is reclaimed at sale, but not applicable since it can't be used on your primary residence, instead used for investment property. Maybe he is thinking about capital gains. If you sell your home and profit on it you *may* have to pay capital gains depending on the situation.

Ok, thanks for admitting you don't know what the hell you are talking about. There is benefits to doing bi-weekly payments, which is probably what you are thinking. I don't know much about it other than most mortgage companies don't allow it so that is why I haven't looked into it much. From what little I do remember it is more about the timing of the payment that affects how the interest is compounded or something like that. Again before you even take the time to figure it out first ask if your mortgage company will allow it.

But it is not just making an extra payment a year. Use the calculator and see for yourself, what you see is what you get by paying more principle each month, ie extra payment a year.

Sorry it looks like a 23 year note.

http://wiki.answers.com/Q/Does_makin..._of_the_loa n

thanks for your feedback Will. What I'm trying to prevent is to be in over my head with trying to sell the house in 7 to 10 years. Of course real estate appreciates, but if i can pay off a bit more faster thats more $$ in my pocket.

Originally I wanted to get a 20 year loan, but they don't exist, only 15 or 30. 15 was pushing it but 30 was a bit more comfortable. My first payment I made was based on a 15 year number but my accountant told me to hold off

I heard it was every two weeks. Its not rocket science, your just making 26 payments a year instead of 24. This works well for people who get paid every two weeks versus twice a month.

Will :thumbsup:thumbsup For the time you put in to helping this guy. Really awesome.

Man 30 year mortgage sounds so scary. My family always preached don't buy what you can't afford. Growing up we were taught to live without that which you can't afford. It's a valuable lesson and really forces you to work hard and save even harder.

How much did you put down? (down payment)

I personally would rather stick that money into my IRA. Rates are so low right now, I would take advantage of that money by using it elsewhere. Of course everyone's situation is different.

A financial advisor of some sort may help you find the best solution for your particular situation.

+1 :thumbsup

Actually paying it off sooner is the opposite of $$ in your pocket. Aren't you using money from your pocket to pay it off? I agree with woj that your effective rate is about 3.8%. Wouldn't you rather have a long loan at 3.8% if you can make 6-8% elsewhere with the money that would go to pay it off early? Especially if it's in stocks or bonds which is much more liquid than payments to your bank. If you need the money down the road you'll appreciate it being liquid.

regardless...interest is calculated over time..so the sooner you pay off your mortgage the better
if you pay an extra 5k one year you will probably save 5k in interest

i enjoyed reading this thread though..lol

My question is: should I use Paxum or not? :winkwink:

I think you are confusing yourself, up top you said one extra payment per year: Now you are saying one extra payment per month.

I wouldn't recommend putting the money into stocks. It's a gamble, you can win or lose. Especially if he doesn't have a lot of experience with stocks. We are not talking about disposable income here, he can't afford to lose this money. You have to remember this is also a guy who "invested" all of his savings into some ponzi scam, unknowingly of course. How much is the current bond rate even going for??

If he pays down his mortgage he is saving about 4% net interest, which is the same as making 4% return on investment without having to pay capital gains or income on the money as he would if he invested it.

The "invest the money" vs paying more towards your mortgage is wise to do but not for most people. It's also called making money off of the banks money. It works better for people who are doing investment/commercial property and are experienced with this type of stuff, not Joe blow the home owner. For a lot of people it is easier and just safer for them to pay down a mortgage and save the money from paying interest, building more equity in their home and then if they have an emergency they can do a HELOC and get some money out.

He is also worried about being upside down and having to come out of pocket (one big lump sum) when he sells the house in a couple years. He is looking for an conservative approach. If he puts that extra money into stocks he could lose it and have nothing. You have to understand people's situations and risk tolerances and what they are looking to accomplish, what works for you doesn't always work for other people or their situation.

The other thing is, it is hard to just pop in and say what is best for someone like this to do without knowing his whole financial situation. Like for example, if he has a couple thousand dollars of credit card debt and is paying 20% interest, he should be paying the extra money each month towards that FIRST and get it paid off before he even thinks about doing anything else.

If you are in the US, use CHECKS!!!! :thumbsup ;)

You Americans are so fortunate to be able able to write off your mortgage interest, we aren't so lucky in the great white north.

The only way we can deduct interest is if it's for an investment property, not our main residence.

Good on you will for putting so much time into your answers.

He's asking what the best thing to do is. If we are talking about a 30 year loan I don't think he has to worry about diversified stock portfolio (say an S&P 500 index fund) being down over that period. As long as he takes his extra money which he planned to pay off his loan with and puts it in the fund each month or at regular intervals he'll be better off. In fact the fluctuations in share price will actually better for him long term.

thanks... you bring up another good point, there has always been rumblings about trying to get that tax deduction removed. I think I remember reading something about Obama trying to do away with it or limit the people who can take the deduction. Tax deductions like this are not set in stone, and while I don't think they would take it away, it is possible. Which would take away factoring in the tax deduction into the "invest the money " strategy making you have to make an even larger return with the money vs using it pay down your mortgage.

Also, the invest the money strategy really is for should you get a loan in the first place vs financing it. We talking about a couple hundred a month here. It's more applicable when you looking at do I get a loan for 500K at 5% and invest my own 500K into something else and try to make 8-10% or do I just pay cash for the property and save on not having to pay interest each money.

obviously you missed the part where he said he is looking to sell the house in 7 years. Which in reality will likely be less than that as most people (younger in particular) always keep things for shorter periods of time than they planned. That doesn't give him a lot of time to regain his losses if the stock he buys tanks over the next couple years. Over 30 years, yeah you should be fine with the market.

Sorry the "stock market" guarantees you shit, especially short term. Risk adverse people should avoid it especially risk adverse people who are counting on the money.

The deficit commission has recommended doing away with, or limiting, the tax benefits of purchasing a house. So yes, that can disappear at any time. The way things are going, I do think it will be at minimum limited at some point in the future. I don't think they will completely strip it because a lot of people do depend on it, it would be a political hellfire, but limiting the benefits could definitely happen.

A couple hundred a month is plenty of money to "invest." Investing isn't just stocks and bonds, and many financial advisors even say that people should not consider messing with stocks and bonds until they have other vehicles completely maxed out... such as 401(k) and IRA. Both 401(k) and IRA offer really great tax benefits (which of course could be pulled sometime down the line.) Although in this situation, I think the thread starter is self-employed so he may not have access to the same exact vehicles as a company employee, but I do know that there are IRA like vehicles for the self-employed.

If you break down the math... sticking that $100 a month into a IRA should earn you more money than paying down your low interest loan. On top of that, the fund will continue growing exponentially over time... you aren't going to see that by paying off your house. And then the tax benefits as well...

With this argument you're going to have one group of people that cheer for paying off the house and another group of people that cheer for investing the excess money. Every math breakdown I have seen and done pushes towards investing, but it really depends on what level of risk the person is willing to take and what their long-term goals are.

Investments stomp houses long term.

And houses are a great guarantee?

We are right after a housing bubble burst and going through a bad economy. I think the risk that his house will be worth less than it is today in 7 years is also remote. I will concede however that if someone is risk adverse then they probably shouldn't try to invest all of their extra money. The reason is if they get scared they would end up selling at the worst possible time. Maybe the best thing for him is to do some early loan pay down and some long-term investments.

houses are typically easier to play then stocks

stocks move all over the place

real estate..its up or down...or everyone knows its going up or down

eh..and then some people still get fucked

but its better then stock market i think for the average person

Assuming you have equity in your house and you expect that to hold until you sell then look at it this way. If you can earn more than 5.125% on your money don't pay extra if you aren't sure you can get a return better than that you should make the extra payments.

with stocks at least you know how much your stocks are worth and you can sell within seconds at anytime... with real estate you have no idea, you may think you own a $350k house because that's how much you paid for it, try to sell it and either get no offers, or get offers for like $250k... you can wait years for a more reasonable offer or take a 100k hit...

it doesn't sound that safe or easy to me...