mortgage lump-sum doesn't save money?

Discussion in 'Financial Planning' started by dmill945@yahoo.com, Jan 19, 2012.

  1. Guest

    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.)
     
    , Jan 19, 2012
    #1
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  2. Ron Peterson Guest

    On Jan 19, 9:59 am, 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
     
    Ron Peterson, Jan 19, 2012
    #2
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  3. Pico Rico Guest

    <> wrote in message
    news:...
    > 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.
     
    Pico Rico, Jan 19, 2012
    #3
  4. Reed Guest

    On 1/19/12 12:59 PM, 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.
     
    Reed, Jan 19, 2012
    #4
  5. 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.
     
    David S Meyers CFP, Jan 19, 2012
    #5
  6. Don Guest

    On Jan 19, 12:04 pm, David S Meyers CFP <> 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.
     
    Don, Jan 20, 2012
    #6
  7. DA Guest

    responding to
    http://www.beansmart.com/financial/mortgage-lump-sum-doesn-t-save-money-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.


    -------------------------------------
    |_/|
    | @ @ Woof!
    | < > _
    | _/------____ ((| |))
    | `--' |
    ____|_ ___| |___.'
    /_/_____/____/_______|
     
    DA, Jan 25, 2012
    #7
  8. Don;737067 Wrote:
    > On Jan 19, 12:04*pm, David S Meyers CFP 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,
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    --
    stevenricherd
     
    stevenricherd, Jan 25, 2012
    #8
  9. Don Guest

    On Jan 25, 8:48 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.


    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.
     
    Don, Jan 25, 2012
    #9
  10. JoeTaxpayer Guest

    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?
     
    JoeTaxpayer, Jan 27, 2012
    #10
  11. bklynboy VIP Member

    Joined:
    Oct 12, 2011
    Messages:
    281
    Location:
    NYC
    I agree with Joe Taxpayer. I maintain a mortage and refuse to prepay even though I have the funds to do so. I invest my excess cash in stocks and at least for the past 3 1/2 years am up quite nicely. I have a long term focus and pick my own stocks and believe this is the best place to make your money work for you. I think too many people are still scared after the 2008 crash and never recovered confidence in equities.
     
    bklynboy, Jan 30, 2012
    #11
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