Mortgages: Interest Calculation/Recalculation

[DJRR]

Quote:

Originally Posted by Finance Dave Answer is B. But you can take the $5,000, and "exhaust" all future months' principal (starting in month 3), until you run out of the $5,000...and that will tell you how many months you just took off your loan by paying the additional $5,000. My guess is that it will be significant.

This is wrong. It is simple interest. You save the interest each month. You do not have to wait until the last payment, neither do you get it all at once. These are, apparently, both common misconceptions .

The term is shorter because you pay less interest. The reason is because your pay less interest EACH month because your principal balance is lower.

Maybe it is easier to think of it as a non-amortizing interest only loan. If you owe 1,000 and the interest is 12% you pay $10 per month. If you "prepay" $500 then you only pay $5 per month. You have saved interest, but your term is exactly the same - indefinite.

Amortization works the same way, except since there is a term that is shortened.

You cannot "invest" or realize the money until the mortgage is paid off or the term expires because you have invested it in your mortgage, hence the liquidity problem, but you do "save" the interest the same as if you bought an investment with the equivalent term and yield.

Edited it to add that if you tried to base your taxes interest deduction on B you would be getting a visit from your friendly IRS agent

[catccc]

Thanks again everyone. I can't believe one bank rep I spoke to once 3-4 years ago has caused all this. I'm not really a total financial dummy. I actually did pass the CPA exam and deal with amortization schedules all the time. I just believed this one guy that told me mortgages were different.

Finance Dave, pretty much everyone says that the answer is A. (Which is what I always assumed until I was told otherwise by said bank rep...) So, I'm curious, why do you believe otherwise? Did you talk to the same guy I did, lol?!

[catccc]

Okay, now that we are all (mostly) on the same page... Which situation is the norm for mortgages, daily or monthly interest accrual?

[MissMolly]

Quote:

Originally Posted by catccc Okay, now that we are all (mostly) on the same page... Which situation is the norm for mortgages, daily or monthly interest accrual?

Monthly. It doesn't matter if you pay your payment on the 1st of the month or the 30th - interest will be exactly the same (but watch out for those late charges )

[Nords]

Quote:

Originally Posted by catccc Okay, so I have one Yes, I'm correct, and one No, you are not. I should clarify to pb4uski that I understand that typically, loans are recalculated and the interest changes when the principal does. But I am asking about home mortgages specifically, which I was told by a bank rep typically do not recalculate for lowered principal unless there is specific language stating such recalculations, or if you "recast" the mortgage. Meaning the interest owed is set in stone until the loan is ended by complete repayment. I understand how amortization schedules work, I just was told that the bank will not repeatedly "throw out" the old schedule and make up a new one to accomodate for your additional principal payments. Anyone else care to weigh in? If you can confirm or deny my understanding, can you let me know how you know? (i.e. "that is how my mortgage seemed to work" weighs less heavily than "I've been a mortgage loan officer for 15 years.") At any rate, I do appreciate all responses.

Math by majority vote. Interesting. I wish that tactic could change the result of the calculation.

I wonder whether the bank staff have any financial interest in helping you make a decision. It's like asking a surgeon if you need surgery. It's like handing your credit card to the car dealer to find out how much payment you can afford. It's like asking a housepainter if your house... well... you get the point.

I don't know about you guys, but even BofA (arguably one of the most incompetent mortgage processors I've ever seen) manages to spit out an annual statement telling me how much principal and how much interest I've paid each year. If I pay more principal than required by the mortgage payment, then the very next month the principal balance is reduced by the amount of the excess payment. They also tell you on the 1099 how much interest you've paid, and if you're paying down the balance early then you're going to pay less interest than forecast by the amortization schedule.

Maybe there's a confusion over terminology. The bank is unlikely to change the interest rate of the loan (it'll stay fixed at 4% for 30 years or whatever) but the dollar amount of the interest paid will change each month as the remaining principal balance drops. I may be making the same vocabulary mistake, but I think "recast" refers to changing the interest rate of the loan-- not the dollar amount of interest paid.

So if you pay more principal one month, the bank's computer will automatically note that (assuming the bank staff process it correctly) and the following month a little more of your payment will go to principal than forecast by the old amortization schedule. On the mortgage and the closing documents it'll say something like "no penalty or fee for early payment". But I doubt you'll see a detailed description of the process by which the bank computer calculates the amortization of a loan with prepayments.

Quote:

Originally Posted by catccc I'm sure it depends on the mortgage, but generally speaking, am I understanding this correctly? So I guess if you want to pay off your mortgage early, it is better to put the extra you'd put towards the principal someplace else safe (savings account) and then once your savings account balance is equal to the remaining principal on the mortgage, and then completely payoff/end the loan at that time?

You could do that if you wanted to. It certainly gives you more liquidity and more choices.

However it's highly likely that your savings account is paying 0.5%-1%/year while your mortgage is costing you 3-4%/year. In other words you're losing money by stashing your money in a savings account instead of prepaying the mortgage. That's your cost of keeping your opportunities open.

[MissMolly]

Quote:

Originally Posted by Nords Math by majority vote. Interesting. I wish that tactic could change the result of the calculation. I wonder whether the bank staff have any financial interest in helping you make a decision. It's like asking a surgeon if you need surgery. It's like handing your credit card to the car dealer to find out how much payment you can afford. It's like asking a housepainter if your house... well... you get the point. I don't know about you guys, but even BofA (arguably one of the most incompetent mortgage processors I've ever seen) manages to spit out an annual statement telling me how much principal and how much interest I've paid each year. If I pay more principal than required by the mortgage payment, then the very next month the principal balance is reduced by the amount of the excess payment. They also tell you on the 1099 how much interest you've paid, and if you're paying down the balance early then you're going to pay less interest than forecast by the amortization schedule. Maybe there's a confusion over terminology. The bank is unlikely to change the interest rate of the loan (it'll stay fixed at 4% for 30 years or whatever) but the dollar amount of the interest paid will change each month as the remaining principal balance drops. I may be making the same vocabulary mistake, but I think "recast" refers to changing the interest rate of the loan-- not the dollar amount of interest paid. So if you pay more principal one month, the bank's computer will automatically note that (assuming the bank staff process it correctly) and the following month a little more of your payment will go to principal than forecast by the old amortization schedule. On the mortgage and the closing documents it'll say something like "no penalty or fee for early payment". But I doubt you'll see a detailed description of the process by which the bank computer calculates the amortization of a loan with prepayments. You could do that if you wanted to. It certainly gives you more liquidity and more choices. However it's highly likely that your savings account is paying 0.5%-1%/year while your mortgage is costing you 3-4%/year. In other words you're losing money by stashing your money in a savings account instead of prepaying the mortgage. That's your cost of keeping your opportunities open.

Recasting can also mean changing the term of the mortgage without any change to the interest rate. Assuming the change in term is to lengthen the maturity date, and keeping the interest rate the same, the remaining unpaid balance woud be reamortized over the new, extended term and would result in lower monthly payments.

[catccc]

Quote:

Originally Posted by Nords Math by majority vote. Interesting. I wish that tactic could change the result of the calculation. I wonder whether the bank staff have any financial interest in helping you make a decision. It's like asking a surgeon if you need surgery. It's like handing your credit card to the car dealer to find out how much payment you can afford. It's like asking a housepainter if your house... well... you get the point. I don't know about you guys, but even BofA (arguably one of the most incompetent mortgage processors I've ever seen) manages to spit out an annual statement telling me how much principal and how much interest I've paid each year. If I pay more principal than required by the mortgage payment, then the very next month the principal balance is reduced by the amount of the excess payment. They also tell you on the 1099 how much interest you've paid, and if you're paying down the balance early then you're going to pay less interest than forecast by the amortization schedule. Maybe there's a confusion over terminology. The bank is unlikely to change the interest rate of the loan (it'll stay fixed at 4% for 30 years or whatever) but the dollar amount of the interest paid will change each month as the remaining principal balance drops. I may be making the same vocabulary mistake, but I think "recast" refers to changing the interest rate of the loan-- not the dollar amount of interest paid. So if you pay more principal one month, the bank's computer will automatically note that (assuming the bank staff process it correctly) and the following month a little more of your payment will go to principal than forecast by the old amortization schedule. On the mortgage and the closing documents it'll say something like "no penalty or fee for early payment". But I doubt you'll see a detailed description of the process by which the bank computer calculates the amortization of a loan with prepayments. You could do that if you wanted to. It certainly gives you more liquidity and more choices. However it's highly likely that your savings account is paying 0.5%-1%/year while your mortgage is costing you 3-4%/year. In other words you're losing money by stashing your money in a savings account instead of prepaying the mortgage. That's your cost of keeping your opportunities open.

1. Well, if the bank rep was trying to get more $$ out of me, he would have preferred to tell me the truth, which is that the interest recalculates, because if it didn't, I'd choose a 15 yr over a 30 yr, resulting in less interest income to the bank. I think he just plain old didn't know how it worked and told me the wrong thing. I even remember him remarking "Oh, no, the interest won't change, the bank is expecting to collect a certain amount each month until the loan is paid off, whether it's early or on time." Coincidentally, it very well may have been BoA I was speaking with...

2. I was all set on a 15 yr mortgage, just because I really wanted the emotional freedom of knowing in 15 years I'd be done. But someone pointed out with rates as low as they are, I could be "laughing all the way to the bank" with CDs that pay 5-6% in future years. So getting a 30 year would allow me to put excess cash into the mortgage (because I cannot find a safe 3% right now) and possibly changing my tune as rates rise. I remember my savings account paying 5-6% in 2006 or so. It wasn't all that long ago, I could see it coming back. And if not, than I'd just keep plugging away at the mortgage, assuming the status of emergency funds was fine and retirement contributions were still maxed. I'm pretty risk averse and wouldn't need cash beyond an appropriate emergency fund for "opportunities."

[catccc]

Quote:

Originally Posted by MissMolly Recasting can also mean changing the term of the mortgage without any change to the interest rate. Assuming the change in term is to lengthen the maturity date, and keeping the interest rate the same, the remaining unpaid balance woud be reamortized over the new, extended term and would result in lower monthly payments.

So nobody ever recasts to shorten a loan life because that is inherent to the way a regular mortgage works, right?

[MissMolly]

Quote:

Originally Posted by catccc So nobody ever recasts to shorten a loan life because that is inherent to the way a regular mortgage works, right?

Not in my exerience, but that is not to say it's hasn't been done. Besides, if you want to shorten the life of a mortgage, simply make extra payments to principal. No point in going through all the paperwork when you can accomplish the same thing with the extra payments.

What used to be called "recasting" is now what is referred to as a loan modification.

[mathjak107]

actually the best deal around would have been 5 year adjustables since most folks move every 5-7 years or refinance.

for now things may have slowed down but only because of conditions dictating that we may have to stay put longer. but thats not what we would be doing if we could sell or refinance.

[catccc]

Quote:

Originally Posted by MissMolly Not in my exerience, but that is not to say it's hasn't been done. Besides, if you want to shorten the life of a mortgage, simply make extra payments to principal. No point in going through all the paperwork when you can accomplish the same thing with the extra payments. What used to be called "recasting" is now what is referred to as a loan modification.

So why would anyone bother going thru all the paperwork? Just to be more committed to the early payoff?

Thanks for all your help here, MissMolly!

[MissMolly]

Quote:

Originally Posted by catccc So why would anyone bother going thru all the paperwork? Just to be more committed to the early payoff? Thanks for all your help here, MissMolly!

Well, like I said, I've never known anyone to "recast" a loan keeping the same interest rate but reducing the term. However, many people take out a 15-year or 20-year mortgage as opposed to a 30-year because the rates are better for a shorter term loan.

[Nords]

Quote:

Originally Posted by MissMolly Well, like I said, I've never known anyone to "recast" a loan keeping the same interest rate but reducing the term. However, many people take out a 15-year or 20-year mortgage as opposed to a 30-year because the rates are better for a shorter term loan.

A couple decades ago we changed our mortgage from a 30-year loan to a 10-year loan because of some old (no longer in effect) "use it or lose it" rules on military housing allowances.

But even then it wasn't a "recast". It was a no-cost refinance to pay off the old mortgage with the new one.