OMY-Syndrome
Confused about dryer sheets
Actually, no you aren't. You pay interest based on the remaining principal balance. If you pay a payment the first day of the month, your balance is decreased by the amount applied to principal. If you pay another payment the next day, interest is calculated on that new balance. It doesn't stay the same as it was on the first of the month. Interest is always recalculated on the remaining balance each time a payment is made.
Actually, I am correct. The previous months interest is added to the current balance at the beginning of the month.If you make an extra principle payment during the month they do not make any additional interest calculations.The only time they charge a pro-rated interest payment, is when you pay off your mortgage, and when they do that they use the current balance, not the balance at the beginning of that month. I will give you some examples to better explain how this works.For the sake of simplicity in my examples I will use $100,000 beginning balance, 6% annual interest rate, and a $1000 regular monthly payment.
Example 1: Calculating interest when an extra interest payment is made that month.
Month 1
beginning balance: $100,000
Day 1: interest charge for last month: $ 500(6% / 12 = .5%)
Day 1: This month's payment: $ 1,000
Day 1: Balance at end of day: $ 99,500
Day 30: Extra payment: $ 10,000
Ending balance month 1: $ 89,500
Month 2
beginning balance: $89,500
Day1: interest charge for last month: $ 447.50 (6% / 12 = .5%)
Day1: This months payment: $ 1,000
Day1: balance at end of day: $ 88,947.50
As you can see from this example, it does not matter what day that extra principle payment is made. When they calculate interest you essentially get credit like that principle payment was there the whole month.
You can similarly save money by understanding the way they calculate interest when it comes time to pay off the whole mortgage. When they do the pro-rating of interest, they look at the current balance, and the number of days left in the month.In other words you can save money by making a big principle payment, before the final payoff.Here are two more examples to illustrate what I am talking about.For simplicity I will not include any deed recording fees, or other similar fees, as those would be the same in either case.
Example 2: Paying it off all at once on the 15th
Day 1 Beginning balance: $ 100,000
Day 1: interest charge for last month: $ 500
Day 1: This months payment: $ 1,000
Day 1: Balance at end of day: $ 99,500
Day 15: Payoff interest calculated: $ 248.75(15 days at 6% annual = .25%)
Day 15: Final payoff amount: $ 99,748.75
Day 15: End of day loan balance: $ 0
Total payments made this month: $ 100,748.75
Example 3: Making an extra payment before the final payoff
Day 1 Beginning balance: $100,000
Day 1: interest charge for last month: $500
Day 1: This months payment: $1,000
Day 1: Balance at end of day: $99,500
Day 10: Extra principle payment: $ 99,400
Day 10: Balance at end of day: $ 100
Day 15: Payoff interested calculated: $00.25 (15 days at 6% annual = .25%)
Day 15: Final payoff amount: $ 100.25
Day 15: End of day loan balance: $ 0
Total payments made this month $ 100,500.25
Now I understand why people might be skeptical. When the mortgage expert I talked to explained this to me, I was very surprised, and asked her multiple times just to make sure I understood it correctly.When I paid off my mortgage I used this information to minimize my interest. I calculated all the interest just as she said to, and it matched the bank's interest down to the penny.So I got confirmation that this is in fact how they calculate things.
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