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mortgage lump-sum doesn't save money?

 
 
dmill945@yahoo.com
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      01-19-2012, 05:59 PM
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?

(Sorry if this is a silly question, it just seems I'm missing
something about lump-sum prepaying, and I want to understand why it
saves money. Thanks.)

 
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Ron Peterson
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      01-19-2012, 06:45 PM
On Jan 19, 9:59*am, (E-Mail Removed) wrote:
> 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?


> (Sorry if this is a silly question, it just seems I'm missing
> something about lump-sum prepaying, and I want to understand why it
> saves money. *Thanks.)


You are reducing the principal on your mortgage by $12,000 that
reduces your interest by $10,000 over the life of the loan so your
future payments are reduced by $22,000 (principal and interest).

--
Ron

 
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Pico Rico
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      01-19-2012, 08:02 PM

<(E-Mail Removed)> wrote in message
news:(E-Mail Removed)...
> 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?
>
> (Sorry if this is a silly question, it just seems I'm missing
> something about lump-sum prepaying, and I want to understand why it
> saves money. Thanks.)
>


you have to give the bank that $12,000 in principal sometime. If you give
it early, you save interest.

 
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Reed
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      01-19-2012, 08:03 PM
On 1/19/12 12:59 PM, (E-Mail Removed) wrote:
> 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?
>
> (Sorry if this is a silly question, it just seems I'm missing
> something about lump-sum prepaying, and I want to understand why it
> saves money. Thanks.)
>

It works, in your example, because the $12K pays off the outstanding
balance (principal)on the loan. The $10K interest would be in addition
to the $12K, so at the end of your 10 years you would have paid $22K
total. (BTW be careful of any pre-payment penalties.)

Don't fall for the income tax deduction argument either. Why pay $1.00
in interest, to only get a .25 cent return, **if you don't have to** !!!

Also, watch for the time when, because the interest deduction
decreases over life of mortgage, your total itemized deductions can
become less than the Standard Deduction. That happened to me about 12
years into a 30 yr mortgage.

 
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David S Meyers CFP
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      01-19-2012, 08:04 PM
(E-Mail Removed) 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.

 
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Don
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      01-20-2012, 03:21 AM
On Jan 19, 12:04*pm, David S Meyers CFP <(E-Mail Removed)> wrote:

> 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?


Another commonly occurring situation is where someone already has a
good car to get to work and no urgent needs, but receives a windfall
that can be used either to pay off the mortgage or invest in something
else. Finding an investment with a higher rate of return than the
mortgage interest rate is not as easy as it sounds. Better a
guaranteed 6% than an uncertain and risky possibility of 8% (less the
cost of finding and investing in the alternative product). And if you
are thinking of 10% or more the risk goes way up! I would pay off the
mortgage.

 
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DA
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      01-25-2012, 04:48 PM
responding to
http://www.beansmart.com/financial/m...ney-17582-.htm
DA wrote:
Don wrote:

> Another commonly occurring situation is where someone already has a
> good car to get to work and no urgent needs, but receives a windfall
> that can be used either to pay off the mortgage or invest in something
> else. Finding an investment with a higher rate of return than the
> mortgage interest rate is not as easy as it sounds. Better a
> guaranteed 6% than an uncertain and risky possibility of 8% (less the
> cost of finding and investing in the alternative product). And if you
> are thinking of 10% or more the risk goes way up! I would pay off the
> mortgage.


Given the investment options these days, I would pay off ANY debt before
investing into anything. Even a guaranteed 4% saving on the lowest
mortgage out there is better than almost assured losses on stocks.


-------------------------------------
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stevenricherd
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      01-25-2012, 04:49 PM

Don;737067 Wrote:
> On Jan 19, 12:04*pm, David S Meyers CFP (E-Mail Removed) wrote:
> -
> 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?-
>
> Another commonly occurring situation is where someone already has a
> good car to get to work and no urgent needs, but receives a windfall
> that can be used either to pay off the mortgage or invest in something
> else. Finding an investment with a higher rate of return than the
> mortgage interest rate is not as easy as it sounds. Better a
> guaranteed 6% than an uncertain and risky possibility of 8% (less the
> cost of finding and investing in the alternative product). And if you
> are thinking of 10% or more the risk goes way up! I would pay off the
> mortgage.


Get the best risk coverage over the issues that are frequently arise,
reduce premium rates by taking plan designed especially for your
industry type.




--
stevenricherd

 
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Don
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      01-25-2012, 06:48 PM
On Jan 25, 8:48*am, DA <(E-Mail Removed)> wrote:

> Given the investment options these days, I would pay off ANY debt before
> investing into anything. Even a guaranteed 4% saving on the lowest
> mortgage out there is better than almost assured losses on stocks.


Agreed. Hoping for investment returns greater than the interest paid
on any form of debt seems to me very risky, not just these days but
any time. But after all debt is paid off and tax-advantaged government
plans, company pensions, etc. are in place, I would not be averse to
some investment in stocks, as well as taking advantage of the
depressed prices of real estate in some areas.

 
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JoeTaxpayer
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      01-27-2012, 11:42 PM
On 1/25/12 11:48 AM, DA wrote:

> Given the investment options these days, I would pay off ANY debt before
> investing into anything. Even a guaranteed 4% saving on the lowest
> mortgage out there is better than almost assured losses on stocks.
>


I struggle with this response. At 3.5% my after tax cost is 2.52%.
The DVY (Dow Dividend ETF) yields about 3.4% or after 15% div rate, or
2.89. You can say that on $100K this is only a net $370, so why risk it?
I'd reply that I don't expect the next ten years to yield zero, and even
at zero, I am a tiny bit ahead. At a normal growth of 6-8% 10 years
could see the money double, and a $100K gain is the potential.

My bet is the next ten will be 5-6%, but my confidence isn't high as to
that accuracy. Why are you "almost assured losses on stocks?" It seems
to me when people are as scared as you appear to be, I should be backing
up the truck and loading up.
Do you really see the ten year downside as significant?

 
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