Relay-Version: version B 2.10 5/3/83; site utzoo.UUCP Posting-Version: version B 2.10.1 6/24/83; site alice.UUCP Path: utzoo!watmath!clyde!cbosgd!ihnp4!mhuxn!mhuxr!ulysses!allegra!alice!ark From: ark@alice.UucP (Andrew Koenig) Newsgroups: net.consumers Subject: Re: principle only mortgage payments Message-ID: <4574@alice.UUCP> Date: Sun, 17-Nov-85 13:11:12 EST Article-I.D.: alice.4574 Posted: Sun Nov 17 13:11:12 1985 Date-Received: Mon, 18-Nov-85 07:38:06 EST References: <480@mit-bug.UUCP> Organization: Bell Labs, Murray Hill Lines: 68 Whether or not you can pay additional principal (please note the spelling!) on your mortgage depends on whether the lender allows it. This, in turn, depends at least in part on whether the laws of your state require the lender to allow it. In New Jersey, for example, all mortgage loans must be prepayable in any part without penalty. Such loans are sometimes called "simple interest" loans. Here's how it works. On January 1, you closed on a house and got a $100,000 loan at 12% nominal rate to finance it. Although the banks here say the loan is 12%/year, it is really 1%/month, or, if you like, 12%/year compounded monthly. Thus, at the end of January, you owe the bank: 100,000 your principal as of January 1 + 1,000 1% interest on your principal. plus enough extra to make up the payment you agreed on (which, according to our assumptions, is $1028.61 for a 30-year term). This extra is $28.61 for the first payment, so after you have made this payment, you owe the bank $99971.39. Now, at the end of February, you owe the bank 99,971.39 your principal as of February 1 + 999.71 1% interest on your principal. plus enough extra to bring your payment up to $1028.61. This extra is $28.90 this time around. See, you're paying it off already! :-) Here are the similar figures for the first year: period balance principal interest 1 100000.00 28.61 1000.00 2 99971.39 28.90 999.71 3 99942.49 29.19 999.42 4 99913.30 29.48 999.13 5 99883.82 29.77 998.84 6 99854.05 30.07 998.54 7 99823.97 30.37 998.24 8 99793.60 30.68 997.94 9 99762.93 30.98 997.63 10 99731.94 31.29 997.32 11 99700.65 31.61 997.01 12 99669.04 31.92 996.69 The important point to realize is that on a simple interest loan with a fixed payment and interest rate, the only thing that determines how much time you have left to pay it off is what your principal is. For instance, my $1028.61 payment at the end of January reduced my balance to $99971.39. If I had paid $1086.70 instead, I would have reduced my balance to $99913.30, and would effectively now be beginning period 4. I would effectively have reduced the term of my loan by two months for the cost of $58.09. Sounds like an irresistable deal, right? Well maybe. If instead I had taken that $58.09 and invested it at 12% a year, compounded monthly, I would have exactly enough money 29 years and 10 months from now to pay off the balance of the loan, two months early. Thus it would seem that whether or not to pay off part of your mortgage early depends on the alternative opportunities for investing the money. But even this is not true, for two reasons: (1) if you invest the money, you can presumably get it back if you need it before your mortgage term expires, and (2) two alternatives that appear the same on the surface may be very different when tax consequences are taken into account. And here's where I must stop trying to give advice. I'm a programmer, not a tax lawyer.