Mortgages: Interest Calculation/Recalculation

[DJRR]

Quote:

Originally Posted by catccc Thanks! It seems like it's about 1/2 and 1/2 (recalc or not recalc) on what the situation is among colleagues/friends' mortgages, assuming they understand correctly how their mortgages work. I suppose I will just have to comb thru the terms quite finely to see exactly what the deal is if/when I am getting a loan.

It is not half and half. Since 90% of all mortgages are FNMA, FHLMC or FHA it is doubtful any work differently. I have never seen one.

You are confusing two things.

1. The monthly payment - This never changes on a fixed rate mortgage unless you "recast" the loan.

2. The monthly amount applied to interest - This changes every month depending on the amount of principal remaining.

To make it simple. If your monthly payment is 1,000 and you pay 800 interest and 200 to principal and you prepay a big chunk your next month payment will be 1,000 but it will be 600 interest and 400 principal.

Your original loan was 360 payments, so now you will owe fewer payments because it will amortize earlier. Your savings are realized immediately as you pay less interest the next month. You do not have to wait.

You will lose the liquidity, which is why some recommend to keep the money in a savings account until you are ready to pay it off. If you do this your interest savings will be less, but you will have the money if you need it for something instead of the bank having it.

If you want a lower monthly payment the only way to get one is to refinance or recast the mortgage.

Hope that is clear.

[catccc]

Quote:

Originally Posted by Texas Proud I also do not see anybody that said you were correct....

Okay, I think I actually misread your short post and thought you were concurring. Whoops, sorry about that! I just rounded up a few co-workers (2 are CPAs, you'd think they'd know how their own mortgages work...) who all told me their mortgages do not recalc. So strange that I get such a variety of responses on this.

[catccc]

okay, seems the consensus here is that my understanding is wrong. (And of course for my sake, I hope it is...) It really was based all on that one bank rep/lender's statement, followed by anecdotal details from others. I like to think that the population on these forums is better versed in these kind of details than the general population. Like I said, I'll just be really aware of the language if/when the time comes that I'm signing those loan docs.

[ChiliPepr]

Quote:

Originally Posted by catccc who all told me their mortgages do not recalc. So strange that I get such a variety of responses on this.

I think you are confusing two things.... When you pay extra principal one month, the next month your principal/interest ratio of your mortgage payment will adjust (interest goes down, principal goes up) but your PAYMENT stays the same. Your monthly payment would not change unless you recast your mortgage.

For example, if you pay $1000 extra on your mortgage this month, your principal portion of next month's payment would be higher (and interest lower). And your mortgage would be payed off in less time. If you then recast your mortgage, the bank would take the amount you currently owe and figure out a lower monthly payment that would have you finish paying off your mortgage at your original payoff date (same time as your original note, but with lower payments).

Most companies will let you recast your mortgage only once, with a fee.

[Texas Proud]

Quote:

Originally Posted by catccc okay, seems the consensus here is that my understanding is wrong. (And of course for my sake, I hope it is...) It really was based all on that one bank rep/lender's statement, followed by anecdotal details from others. I like to think that the population on these forums is better versed in these kind of details than the general population. Like I said, I'll just be really aware of the language if/when the time comes that I'm signing those loan docs.

I think DJRR's explanation is the best so far on possibly the confusion.... and the answer...

[catccc]

Further clarification on what I DO understand... Yes, the mortgage payment will be the same unless you recast. Got that. The interest/principal breakdown will change each payment. Got that.

The proportion to which the breakdown changes and whether it is affected by extra principal payments, that was my original question. And it seems overwhelmingly that payments subsequent to an extra principal payment are indeed affected.

Now that you've all brought these points up, I see that my inquires to others were probably subject to much interpretation, would would explain such varied responses...

Another thing, I did misunderstand the recasting process. I thought it meant they'd recalc amortization with the loan ending earlier, not lowering the payment w/ the loan ending at the same time.

Anyway, so this is all very good. This means that going for a 30 year will probably allow the flexibility I want w/o being locked into an early payoff. Now, just need to find a house to buy... thanks all for the assistance!

[rescueme]

Quote:

Originally Posted by rbmrtn I think something is getting lost in translation. To recast or reamortize is different than making extra payments ( as I understand it ). Recast changes the monthly payments which results in a new amortization schedule. Paying extra, the monthly payment stays the same but the allocation between principal/interest changes. They can restrict extra payments or charge prepayment penalties. As others said , get it in writing and get to the details in the documents.

Correct.

We paid off our current home's note, which was for a 30-year term but was retired in 5.5 years.

The only thing that you have to watch is that the bank/CU credits your additional payment as a reduction in principal, not just paying your next month's payment early. To manage that, I always made/submitted two separate checks. Additionally, since I did it in person at the local S&L, I could ensure there was no confusion.

[catccc]

Quote:

Originally Posted by rescueme Correct. We paid off our current home's note, which was for a 30-year term but was retired in 5.5 years. The only thing that you have to watch is that the bank/CU credits your additional payment as a reduction in principal, not just paying your next month's payment early. To manage that, I always made/submitted two separate checks. Additionally, since I did it in person at the local S&L, I could ensure there was no confusion.

Wow, congrats on the aggressive paydown! And thanks for the tip.

[scrabbler1]

Late to the dance, but I agree that DJRR's reply is the best among a set of very good ones.

I took out my first mortgage, a 5-yr ARM, back in 1989. In 1992, I refinanced it into a 1-yr ARM but paid down a small part of added principal just before the refi went through. This added principal changed the expected P/I split in my last regular monthly payment so the old lender refunded to me a tiny part of it when the 2 bank's lawyers met to finish the deal.

In the mid-1990s, my monthly payment changed once a year when the interest rate changed. In some of those years, I paid down some extra principal so the P/I split changed from its original glide path (from the start of the 12-month period in which the new interest rate was in effect). I was always able to figure out to the penny what my total interest paid was for the calendar year before I received the 1098 form, even if I made an extra principal payment (the P/I glide path sometimes changed 2 or 3 times in a calendar year). By 1998 I had paid it off.

As rescueme mentioned, it was important to differentiate additional principal from an early payment. But because I had ACH payment for the regular monthly ones, I used the payment coupons solely for additional principal (the lender told me to do it that way) and there was no problem.

[Finance Dave]

Quote:

Originally Posted by catccc Okay, so I have one Yes, I'm correct, and one No, you are not. 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.

I don't see anyone saying you're "correct"...he just said that's the way he did it.

I agree with p4buski. It's not that they "recalculate" anything, but it will come off the principal balance regardless of how you do it.

The one clarification is that yes, you do avoid the interest when you pay additional principal...but it's a bit misleading. You are saving future interest.

For example, let's say you pay additional in the very first month of your 30-year loan, and don't pay any more additional after that. Then your final payment, 359 payments later, would be smaller (or perhaps zero, depending on how much additional you paid). You really aren't saving anything until the final month...so that interest is deflated. If you want to claim you're saving (I'll make up a number here) $20,000 in interest, then you should discount that back using a PV (present value) formula. Let me give an example to make more sense of this...

Let's say I have a contest whereby I say I'm raffling off $1M. Each person buys a ticket for $1,000, and I'll sell 1,000 tickets. You might think..."well gee, how's he going to make any money doing that...he's collecting $1M, and paying back out $1M". But in the fine print it says that the $1M prize will be paid 5 years from now. I then get to use/invest the money for 5 years, and simply pay the prize at that time...what a deal! Imagine if it was 30 years instead of 5 years! This is exactly what the lottery does in some states....the cash prize is actually typically an annuity paid over many years....and if you want the money in a lump sum now...you get a MUCH smaller amount.

[pb4uski]

Quote:

Originally Posted by catccc ....Anyway, so this is all very good. This means that going for a 30 year will probably allow the flexibility I want w/o being locked into an early payoff. Now, just need to find a house to buy... thanks all for the assistance!

The trade-off of 15 year vs 30 year is that the 15 year interest rate is lower so your interest cost over the life of the loan is lower all else being equal but the 15 year payment is higher and if you run into financial difficulties you still must make the higher payment to avoid default.

If the 15 year payments are comfortable for you but you are worried about the lack of flexibility, you can do a 30 year loan and make the payments on a 15 year loan and your term would be just a bit over 15 years.

For example, let's say your choice is between a 15 year loan at 3.75% or a 30 year loan at 4.00% and you are borrowing $100k, then your monthly payment would be 727.22 a month for the 15 year loan or 477.42 a month for the 30 year loan. However, let's say you take the 30 year loan but pay 727.22 a month - the loan would be paid off in less than 15 1/2 years but if during that 15 1/2 years something blew up and paying 727 a month became a burden you would only have to pay 477 to keep the loan current.

[rescueme]

Quote:

Originally Posted by catccc Wow, congrats on the aggressive paydown! And thanks for the tip.

Well, I had some help. We had just built our home (first one we built, but the forth we had along the journey) and had the specs drawn up to make it our retirement home with a lot of things added for the long term.

While DW never contributed to any expenses (yes, including the note/mortgage) over the years (we always planned to live on only my income - "just in case") she wanted to ensure we entered retirement debt free (see my "rock"). To that end, her contributions, along with my higher principal only payments allowed us to pay off our debt many years earlier than that. As I remember from long gone spreadsheets, we had a bit over $125k in "foregone interest" - IOW money we did not have to put out for that original 30-year term.

An additional note; we made the final payment in late 1999. At that time, we redirected my payments to the equity market. If you remember what happened 2000-02, we were able to buy very cheap and wound up to be able to "cash in" our profits, which lead to our planned ER in 2007 (I did, she didn't - not emotionally ready).

Sometimes you can't beat a bit of planning - along with dumb luck...

[Finance Dave]

Here's a website with a calculator.

http://www.amortization-calc.com/

Try the following:
$100,000 loan
30 years
4% interest
show by month

If you paid an extra $144.56 in month 1 only one time (note this is the principal amount in month 2), you would save $332.85 (this is the interest in month 2), but not until the end of the loan period...30 years later.

$332.85 won't be worth nearly as much in 30 years as it is today. Don't get me wrong...I'm still in favor of paying off early...I just always see these articles saying how you can save hundreds of thousands of dollars by paying off your loan early...yet they fail to mention TVM (time value of money).

[pb4uski]

Quote:

Originally Posted by Finance Dave Here's a website with a calculator. Amortization Schedule Calculator Try the following: $100,000 loan 30 years 4% interest show by month If you paid an extra $144.56 in month 1 only one time (note this is the principal amount in month 2), you would save $332.85 (this is the interest in month 2), but not until the end of the loan period...30 years later. $332.85 won't be worth nearly as much in 30 years as it is today. Don't get me wrong...I'm still in favor of paying off early...I just always see these articles saying how you can save hundreds of thousands of dollars by paying off your loan early...yet they fail to mention TVM (time value of money).

True, but few loans last their entire 30 year term. I've had 7 mortgages over the years and none has lasted its full term.

[Finance Dave]

Quote:

Originally Posted by pb4uski True, but few loans last their entire 30 year term. I've had 7 mortgages over the years and none has lasted its full term.

The concept still applies...if you keep it 8 years, then that amount should be discounted for 8 years, etc.

[catccc]

Quote:

Originally Posted by Finance Dave I don't see anyone saying you're "correct"...he just said that's the way he did it. I agree with p4buski. It's not that they "recalculate" anything, but it will come off the principal balance regardless of how you do it. The one clarification is that yes, you do avoid the interest when you pay additional principal...but it's a bit misleading. You are saving future interest. For example, let's say you pay additional in the very first month of your 30-year loan, and don't pay any more additional after that. Then your final payment, 359 payments later, would be smaller (or perhaps zero, depending on how much additional you paid). You really aren't saving anything until the final month...so that interest is deflated. If you want to claim you're saving (I'll make up a number here) $20,000 in interest, then you should discount that back using a PV (present value) formula. Let me give an example to make more sense of this... Let's say I have a contest whereby I say I'm raffling off $1M. Each person buys a ticket for $1,000, and I'll sell 1,000 tickets. You might think..."well gee, how's he going to make any money doing that...he's collecting $1M, and paying back out $1M". But in the fine print it says that the $1M prize will be paid 5 years from now. I then get to use/invest the money for 5 years, and simply pay the prize at that time...what a deal! Imagine if it was 30 years instead of 5 years! This is exactly what the lottery does in some states....the cash prize is actually typically an annuity paid over many years....and if you want the money in a lump sum now...you get a MUCH smaller amount.

1. yeah, I misread a post... nobody said I was correct. BUT

2. YES! I think you understand my question. My question is about saving future interest, and about not saving anything until the final month. (Unless I'm misunderstanding you. It seems I've been having my fair share of misunderstanding lately.) Okay so instead of asking my question in words, I'll ask it in numbers:

So let's say there's a 100K loan for 30 years at 3%. If you run an amortization schedule, it would say the payment is $421.60.

The 1st month's payment is $250 interest and $171.60 principal. So you pay $421.60. The next month, the payment is of course the same $421.60, but this time it is $249.57 interest and $171.03 principal. That's scenario 1, you just pay the same $421.60 each month and do not pay any extra towards principal. The principal and interest breakout for each payment will follow the original amortization schedule.

Okay, scenario 2: Now let's say instead of paying 421.60 in month 1, you also have them apply another $5,000.00 to the principal as well. In the second month, you pay just the 421.60. HERE IS MY QUESTION. Is the 2nd month payment of 421.60:

A) now 237.07 interest and $184.53 principal because of the extra 5K you paid? Or

B) it is the same $249.57 interest and $171.03 as in scenario 1, because the original amortization schedule dictates the interest/principal breakout?

I think everyone here is telling me it would be the 237.07 interest and $184.53 principal. The bank rep was telling me it be the same old $249.57 interest and $171.03 principal that the original schedule had called for. I of course want the answer to be A....

[Finance Dave]

Quote:

Originally Posted by catccc 1. yeah, I misread a post... nobody said I was correct. BUT 2. YES! I think you understand my question. My question is about saving future interest, and about not saving anything until the final month. (Unless I'm misunderstanding you. It seems I've been having my fair share of misunderstanding lately.) Okay so instead of asking my question in words, I'll ask it in numbers: So let's say there's a 100K loan for 30 years at 3%. If you run an amortization schedule, it would say the payment is $421.60. The 1st month's payment is $250 interest and $171.60 principal. So you pay $421.60. The next month, the payment is of course the same $421.60, but this time it is $249.57 interest and $171.03 principal. That's scenario 1, you just pay the same $421.60 each month and do not pay any extra towards principal. The principal and interest breakout for each payment will follow the original amortization schedule. Okay, scenario 2: Now let's say instead of paying 421.60 in month 1, you also have them apply another $5,000.00 to the principal as well. In the second month, you pay just the 421.60. HERE IS MY QUESTION. Is the 2nd month payment of 421.60: A) now 237.07 interest and $184.53 principal because of the extra 5K you paid? Or B) it is the same $249.57 interest and $171.03 as in scenario 1, because the original amortization schedule dictates the interest/principal breakout? I think everyone here is telling me it would be the 237.07 interest and $184.53 principal. The bank rep was telling me it be the same old $249.57 interest and $171.03 principal that the original schedule had called for. I of course want the answer to be A....

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.

[Gill]

The bank rep doesn't know what they're talking about. When the principal is reduced they're required by law to reduce the amount on which the interest is calculated. To do otherwise would be charging more interest than the note allows.
Bruce

[meierlde]

Quote:

Originally Posted by MBMiner The bank rep doesn't know what they're talking about. When the principal is reduced they're required by law to reduce the amount on which the interest is calculated. To do otherwise would be charging more interest than the note allows. Bruce

Yes mortages charge basically simple interest. A car loan is very different and uses the rule of 72 if paid off early. basically if you have the original amotization table and make a partial prepayment, you can go the the table until the principal is closest and get an idea of the number of months shaved off. (Note that this really works best in the first 10 years of a mortgage) After 20 years the payment is now 1/2 principal and 1/2 interest.

[MissMolly]

I'm sorry Finance Dave, but I have to disagree with you. The answer would be A. I worked 30+ years in the mortgage servicing industry. If extra money is paid towards the principal in any given month, then the principal/interest split on the following month's payment will be different than the original amortization schedule. The interest amout due is indeed recalculated each month based on the amount of remaining principal.