writes:

> Typical case - eg. prepaying $12000 on a mortgage now will save $10000

> in interest over the life of the mortgage. But why isn't this

> actually losing $2000? Is it any different than giving a bank $1.20

> today and getting back $1.00 in 10 years?
Your math isn't right. You are prepaying *principal* and as

a result will be paying less *interest*. You'd still pay the

principal in addition regardless of whether you pay it now or

later.

ie. if you prepay $12000 and save $10000 over the life of

the mortgage, you are paying $12000, period. If you didn't

prepay it, you'd pay $22000 over the life of that mortgage,

the same $12000 in principal *plus* the additional $10000.

What I find annoying about this kind of math is that, while

correct, it's less than half the picture. What they leave

out are opportunity cost and time-value-of-money.

What if, instead of prepaying that $12000, you use it for

something more urgent like, say, a more reliable car so

you can get to work with less hassle, repairs, lost time?

Or if you invested that $12000 in something with a higher

return than your rate of mortgage interest?

And re: time-value-of-money, saying $10000 over the "life

of the mortgage" is pretty meaningless. What's the rate

per *year*? Quick back of the envelope says that $12,000

amortized over 30 years at 4.6% annual incurs a total

cumulative interest paid of just over $10,000. The $10,000

number is nowhere near as important as the 4.6% number

and the standard documentation's insistence on highlighting

that less relevant number just irks me.

The other thing not necessarily discussed here is how the

prepayment affects your future payment schedule. It could

shorten the life of your mortgage, or it could lower your

monthly payments. In 99% of the case, a partial principal

prepayment like that goes to shorten the life of your

mortgage. That's great - you save on the interest over the

lifetime of the mortage, and you are done paying off your

loan a lot faster, but until the loan is paid off, it

doesn't lower your payments - in fact, your payments stay

the same and you simply have less liquidity since it's a

lot harder to get that money back out if you needed it

for something else.

--

David S. Meyers, CFP(R)

http://www.MeyersMoney.com
disclaimer: for educational purposes only. This is not financial advice.