Amortization

[veronak]

I think I should have posted here instead of my financial blog, it just that I rarely visit the forums, I really don't know why any how here we go...my brother went to this real estate seminar, which I think was a waste of money but that is my opinion. As you all know I am trying to save for a house so he was trying to explain “Amortization” here I guess you pay your interest in a separate check early to the bank and apparently they can not charge you for it the following month. My thing is this why not pays on the principal (extra each month) which reduces the total balance on the loan as well as the amount of interest paid. Am I wrong is he right, will amortization actually help you pay the loan off quicker than just paying extra on the principal?

[creditcardfree]

Re: Amortization

Amortization is a term that refers to the gradual paying off of a debt in regular installments over a period of time.

You are better off paying extra on the principal of your mortgage in the long run. The situation your brother describes does not seem to pay additional principal. He's just giving the bank their interest early...not wise in my opinion since it isn't yet due.

Reminds me of having to much withholding taken out of your check and getting a large tax refund...you loaned the government that money interest free.

In my opinion he is not using the word amortization correctly and I think you are right!!

[markio26]

Re: Amortization

we own three properties and we paid an extra $100 on each payment every month... as we made more money we added an extra $50 on each payment every month...and so on... i think it took us 20 yrs... we saved alot of interest money doing this... hth..

[Ima saver]

Re: Amortization

I agree you credit card free, he is not using the word correctly. Pay as much extra as you can on your mortgage each month.

[disneysteve]

Re: Amortization

creditcardfree is correct. If you want to save money, you need to prepay principal, not interest. Interest is calculated based on the outstanding principal, so paying it early doesn't affect anything.

I respectfully disagree with Ima, though. I generally don't believe you should prepay your mortgage. You can do far better investing your money elsewhere. In most cases, a mortgage is low interest debt (and tax deductible, too). As I posted on another thread, my stock mutual funds are up between 10.58% and 39.11% this year. I see no reason to put extra money toward the mortgage, at 5.875%, when I'm earning that much more by investing the money. You need to consider your overall situation, your overall portfolio, your risk tolerance, your age, etc. For some people, paying down the mortgage might be the better way to go (so I don't totally disagree Ima ).

[bjl584]

Re: Amortization

Before paying as much as you can toward the principal each month take a look at the terms and condtions of the loan and your interest rate. If you have a favorable interest rate and have enough deductions to itemize your taxes it may be better for you to pay less on the loan and invest your extra money somewhere else.

[Ima saver]

Re: Amortization

It is ok if you disagree with me disneysteve. When I had a mortgage my interest rate was 9%. I did not know anything about investing other than a regular savings which was paying 6% then. I got my house paid off 30 years ago and haven't had a house mortgage since then. Since we have never made much money, they has enabled me to save a lot of cash for investing.
Also, I have to keep a lot more in cash than most of you so we can pay for houses as we build them. My cash is only earning 5.25% while I am making a land payment at 7%. so I am going to pay the land off when this house sells. It just depends on your circumstances.

[disneysteve]

Re: Amortization

It is ok if you disagree with me disneysteve. When I had a mortgage my interest rate was 9%.

It just depends on your circumstances.

Agreed. If my loan were at 9%, I'd probably consider repaying it also. A "sure thing" 9% return is tough to beat.

[veronak]

Re: Amortization

Thanks a bunch guys, I also did some research and in some cases if you amortize you can pay up to 500% more

[disneysteve]

Re: Amortization

if you amortize you can pay up to 500% more

I'm not sure what you mean by that. You can pay 500% more than what?

[veronak]

Re: Amortization

Sorry disneysteve, my post was not clear...but below you will find the information that I was referring to again I apologize:

There are a few crucial points worth noting when mortgaging a home with an amortized loan. First, there is substantial disparate allocation of the monthly payments toward the interest, especially during the first 18 years of the mortgage. Payment 1 allocates 90% of the total payment towards interest and only $67.09 (or 10%) toward the Principal balance. Not until payment 257 or 21 years into the loan does the payment allocation towards principal and interest even out and subsequently tip the majority of the monthly payment toward Principal balance pay down.

Second, understanding the above statement, the repetitive refinancing of an amortized mortgage loan, even with decreasing interest rates and decreasing Principal balance, can cause the borrower to pay over 500% of the value of the original loan amount. 'Re-amortization' or restarting the amortization schedule via a refinance causes the 90/10 rule of payment allocation to interest and Principal balance accordingly, thus causing substantial monies to be reallocated toward interest again. This economically unfavorable situation is often mitigated by the apparent decrease in monthly payment and interest rate of a refinance, when in fact the borrower is increasing the total cost of the property. This fact is often (understandably) overlooked by borrowers and never addressed by the mortgage professional.

Third, the payment on an amortized mortgage loan remains the same for the entire loan term, regardless of Principal balance owed. For example, the payment on the above scenario will remain $733.76 regardless if the Principal balance is $100,000 or $50,000. Paying down large chunks of the Principal balance in no way affects the monthly payment, it simply reduces the term of the loan, resulting in a quicker payoff. To avoid these caveats of an amortizing mortgage loan many borrowers are choosing an Interest-only loan to satisfy their mortgage financing needs. Interest-only loans have their caveats as well which must be understood before choosing the mortgage payment term that is right for the individual borrower.

[disneysteve]

Re: Amortization

To avoid these caveats of an amortizing mortgage loan many borrowers are choosing an Interest-only loan to satisfy their mortgage financing needs.

Be VERY cautious in how you interpret the information here. It sounds like they are promoting interest-only loans. That is almost definitely NOT the way you want to finance a home. Unless you are absolutely positive that you will sell the home before the interest-only period expires, you could be in big trouble when the principal payments start. A lot of people are finding themselves in that situation now. They bought overpriced homes over the past few years with interest-only loans. Now the principal payments are starting and they can't afford the payments but can't sell the house for as much as they owe on the mortgage. That is part of why foreclosure rates have been shooting up.

As for the 500% issue, that is referring to what can happen if you repeatedly refinance your loan. If you take out a 30-year loan, then 5 years later refinance with another 30 year loan, then a couple years later refinance again with another 30 year loan, even though your payment may drop each time as the interest rate lowers, you aren't actually saving any money over the long term because you are paying more interest and extending the length of the loan. That part is true, as is the third part about the payment remaining the same even if you make extra principal payments. What they fail to mention, though, is that making those extra payments can save you tens of thousands of dollars in interest.

[Ima saver]

Re: Amortization

I have to agree with disneysteve.