Author Topic: The way mortgages work  (Read 9693 times)

postvmvs

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The way mortgages work
« on: September 13, 2016, 04:16:42 PM »
I have what may be a very elementary question:

When paying mortgage, a certain amount of each monthly payment goes towards principle and a certain amount goes towards interest. At the start of loan it is weighted more heavily towards interest and gradually over time the weighting shifts, increasing the amount going to principle and decreasing the amount going to interest.

If one were to prepay the mortgage, which is to say make an additional payment to be used towards the principle, would this cause the weighting on the next month to shift more towards principle than it would have had the extra payment not been made? Or does the weighting staying the same through the course of the loan, but prepaying would simply shortens the end date?

bacchi

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Re: The way mortgages work
« Reply #1 on: September 13, 2016, 04:28:29 PM »
If you make an extra principal payment (and it's applied correctly to principal), the weighting would shift more towards principal than it would have normally.

bop

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Re: The way mortgages work
« Reply #2 on: September 13, 2016, 04:34:13 PM »
Yes, if you make an additional principal payment, that should shift future mortgage payments to be weighed more toward principal than they otherwise would be.   

Here's a way to think about it.  Your interest per month is proportional to the current balance on the loan.  If you make an extra principal payment, you have reduced the loan balance, which reduces monthly interest.  So the amount going toward principal will increase. 

That same reasoning explains why (even without extra payments) the mortgage payments shift over time from majority interest to majority principal.  At the start, your loan balance is highest, so your monthly interest is highest; at the end, your loan balance is lowest, so your monthly interest is lowest. 
« Last Edit: September 13, 2016, 04:37:23 PM by bop »

postvmvs

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Re: The way mortgages work
« Reply #3 on: September 13, 2016, 05:05:13 PM »
Thanks for the responses bacchi and bop!

I also just realized I used 'principle' instead of 'principal'.

Catbert

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Re: The way mortgages work
« Reply #4 on: September 13, 2016, 06:54:15 PM »
Make sure that you are marking the extra $$ as "principal" rather than "prepaying" for the following month.  If you're just sending them October and November's payment early that won't help.

boarder42

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Re: The way mortgages work
« Reply #5 on: September 13, 2016, 07:29:26 PM »
So

1. It's not weighted. You have more debt at the beginning which you are gradually paying down along with your interest costs. You are paying the same percent interest.

2.  You should be asking IF you should be paying down your mortgage and that answer is no if you have a low fixed rate mortgage. You're costing yourself a few years on FIRE and security once FIREd. 

looking at wow look how high the interest is now as a dollar amount is a very very poor way to analyze the cost/risk

Lmoot

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Re: The way mortgages work
« Reply #6 on: September 13, 2016, 08:04:25 PM »
Principal and interest are weighted differently throughout the loan. You can generate the amortization schedule on most lenders' websites, and you will see the breakdown.

I only wanted to pay down part of my mortgage (as an insurance policy, leaving me the ability to recast in a moment's notice if I needed extra cash flow/ to reduce expenses). I decided to prepay as early into the loan as possible because I wanted my future payments to work harder towards the principal (effortless savings). There is a difference between paying down earlier during a mortgage vs paying down later into a mortgage; it makes a difference in how much you save because of how the scale is tilted.

Example of 2 different outcomes, using a lump sum paydown for simplicity:

1) $50,000 one time extra payment, 5 years into 30/3.5%/$250,000 loan = savings of $54,179.44, 7 years, 9 months early

2) $50,000 one time extra payment, 10 years into 30/3.5%/$250,000 loan = savings of $39,257.97/ 6 years, 7 months early

Difference in savings = about $15,000.

Same interest rate. Yes, the interest reamortizes during the loan (not the rate, but the real dollars), however the PITI payment does not because it is designed to be a fixed amount. But, as seen above, even though the amount is fixed, the allocation changes during the course of the loan and can be further manipulated by placing a proverbial thumb on the scale.
« Last Edit: September 13, 2016, 08:21:35 PM by Lmoot »

boarder42

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Re: The way mortgages work
« Reply #7 on: September 14, 2016, 04:14:14 AM »
Or invest the 50k and come out farther ahead your interest savings on a 3.5% loan are negligible. And you're creating MORE risk for your self by pumping money into a house vs leaving it in a more liquidate asset such as an index fund in a taxable account.

And if you're not maxing all tax advantaged accounts then there is 0 reason to pay off a mortgage early.

marty998

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Re: The way mortgages work
« Reply #8 on: September 14, 2016, 04:15:11 AM »
Suggest you try it with your bank and see for yourself.

Nothing beats learning things through doing it.

Lmoot

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Re: The way mortgages work
« Reply #9 on: September 14, 2016, 04:35:20 AM »
Or invest the 50k and come out farther ahead your interest savings on a 3.5% loan are negligible. And you're creating MORE risk for your self by pumping money into a house vs leaving it in a more liquidate asset such as an index fund in a taxable account.

And if you're not maxing all tax advantaged accounts then there is 0 reason to pay off a mortgage early.

Well that wasn't the question the OP asked. There are plenty of other places on here where that is already being debated. Most folks have their reasons why they prefer to do it one way or another.  And just because you lean towards one way, doesn't mean you cannot also make use of other methods as well. Also, just because something is not hypothetically the best way, doesn't mean it is a bad way; and you cannot possibly know for a fact one trumps the other without knowing the individual's situation.

Blindly maxing out tax advantaged accounts because that's the loudest call, is not always the best solution. Many people don't need that much in retirement, particularly if they have other types of investments, and would rather spread and partake in that wealth throughout their life, and not just in the last 15-20 years. An extra $250,000 before the age of 59 1/2, might be more useful to some people than an extra $500,000 after the age of 59 1/2. It is a personal choice, just like those who choose to collect ss ASAP, or defer it in order to get more money.
« Last Edit: September 14, 2016, 04:45:06 AM by Lmoot »

boarder42

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Re: The way mortgages work
« Reply #10 on: September 14, 2016, 05:28:50 AM »
OP has 26 posts on this site and may not actually understand the risk he is taking on and the added time to FIRE by paying down a mortgage.

second your thought that the money in tax advantaged accounts isnt accesible til 59.5 means you arent fully aware of how FIRE works.  90% of my money will be in tax advantaged accounts and i will retire at 37 and use this money.  see below.  in most cases even paying the 10% penalty carries a low tax burden not to mention the other 2 ways to avoid that penalty. 

http://www.madfientist.com/how-to-access-retirement-funds-early/#ck_modal2



the correct way to respond to any question is not just to answer it.  its to figure out why the question is being asked and propose to best possible solution to it. 

if i made a post about the best bridge to jump off to insure death would you simply respond with your personal preference or would you ask more questions. - yes thats extreme.  but when new posters here ask questions that show they dont even understand how mortgage paydown works it likely means they have not researched it enough to know if they should even be paying it down.
« Last Edit: September 14, 2016, 05:32:15 AM by boarder42 »

catccc

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Re: The way mortgages work
« Reply #11 on: September 14, 2016, 08:19:08 AM »
Like others have said, yes, if they correctly apply the extra to the principal, your next payment will be more principal and less interest that it would have been had you not prepaid your mortgage principal.  Be sure your bank applies the extra payment correctly!

Google "amortization calculator" and find one shows the entire amortization schedule for a loan w/ terms you input (I think bankrate does a decent one), and take a close look at the resulting schedule.  Amortization of loans will make a lot of sense if you see it laid out in front of you.  Basically, the interest is calculated on the principal amount, which goes down as you pay off the loan.  But your payment remains the same, which means that every subsequent payment has a lesser portion going to interest.

Like others have pointed out, if you have a low fixed rate, it's likely a mathematical win to not pay it off early and invest instead.  But I understand some people really value the intangible of paying down a loan or not having a loan.

soupcxan

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Re: The way mortgages work
« Reply #12 on: September 14, 2016, 11:53:09 AM »
OP has 26 posts on this site and may not actually understand the risk he is taking on and the added time to FIRE by paying down a mortgage.

second your thought that the money in tax advantaged accounts isnt accesible til 59.5 means you arent fully aware of how FIRE works.  90% of my money will be in tax advantaged accounts and i will retire at 37 and use this money.  see below.  in most cases even paying the 10% penalty carries a low tax burden not to mention the other 2 ways to avoid that penalty. 

http://www.madfientist.com/how-to-access-retirement-funds-early/#ck_modal2



the correct way to respond to any question is not just to answer it.  its to figure out why the question is being asked and propose to best possible solution to it. 

if i made a post about the best bridge to jump off to insure death would you simply respond with your personal preference or would you ask more questions. - yes thats extreme.  but when new posters here ask questions that show they dont even understand how mortgage paydown works it likely means they have not researched it enough to know if they should even be paying it down.

You're completely ignoring the risk-return trade-off between investing in the market and paying down a mortgage. As Lmoot pointed out, there is no one-size-fits-all answer to this despite your opinion to the contrary.

boarder42

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Re: The way mortgages work
« Reply #13 on: September 14, 2016, 12:21:26 PM »
OP has 26 posts on this site and may not actually understand the risk he is taking on and the added time to FIRE by paying down a mortgage.

second your thought that the money in tax advantaged accounts isnt accesible til 59.5 means you arent fully aware of how FIRE works.  90% of my money will be in tax advantaged accounts and i will retire at 37 and use this money.  see below.  in most cases even paying the 10% penalty carries a low tax burden not to mention the other 2 ways to avoid that penalty. 

http://www.madfientist.com/how-to-access-retirement-funds-early/#ck_modal2



the correct way to respond to any question is not just to answer it.  its to figure out why the question is being asked and propose to best possible solution to it. 

if i made a post about the best bridge to jump off to insure death would you simply respond with your personal preference or would you ask more questions. - yes thats extreme.  but when new posters here ask questions that show they dont even understand how mortgage paydown works it likely means they have not researched it enough to know if they should even be paying it down.

You're completely ignoring the risk-return trade-off between investing in the market and paying down a mortgage. As Lmoot pointed out, there is no one-size-fits-all answer to this despite your opinion to the contrary.


i'm not ignoring it ... its been discussed else where.  just pointing out the OP should look into it .  my statement came with a preface of low fixed rate in the US.  and seeing as OP is unaware of how paying down a mortgage works they are likely unaware of their inherent added risk.  show me a math equation where paying down a 3.25-5% 30 year fixed rate mortgage beat putting money in an IRA with vanguard. you cant find it b/c it doesnt exist.

postvmvs

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Re: The way mortgages work
« Reply #14 on: September 14, 2016, 06:46:43 PM »
I'm the OP, and as boarder42 pointed out, I only have a relatively small number of posts. I am more of a reader of the forum rather than a poster. As a reader I am fully aware of the (endless) debate of the risk vs. reward of mortgage prepayment vs. investing all surplus. Over the "long term" the stock market has returned an impressive 10%*, while mortgage rates right now are historically low around 3.5%. There are many points and counterpoints. I could easily cherrypick a 10-year stretch where the stock market did not return 10%**. Then that effective 3.5% "return" on your investment would look pretty rosy. Although some won't even argue numbers, and place great value in the feeling of owning their home outright.

One thing I found interesting from this discussion, was Lmoot pointing out the difference in timing of when a prepayment is made. If one is going to do so, prepaying certainly brings greater result doing it earlier in the loan.

I have actually never prepayed my mortgage, hence the question, nor do I have any immediate plans to do so. And as far as best bridge to jump off, I recommend investigating the dangers of burning charcoal in an enclosed space first. I mean unless one really wants to go out with a splash.

*=oh yeah, inflation... so maybe more like 6 to 7%
**=the 10-year period ending September 1974, with a compound annual decline of 4.3 percent

BlueHouse

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Re: The way mortgages work
« Reply #15 on: September 14, 2016, 07:18:33 PM »
OP has 26 posts on this site and may not actually understand the risk he is taking on and the added time to FIRE by paying down a mortgage.

second your thought that the money in tax advantaged accounts isnt accesible til 59.5 means you arent fully aware of how FIRE works.  90% of my money will be in tax advantaged accounts and i will retire at 37 and use this money.  see below.  in most cases even paying the 10% penalty carries a low tax burden not to mention the other 2 ways to avoid that penalty. 

http://www.madfientist.com/how-to-access-retirement-funds-early/#ck_modal2



the correct way to respond to any question is not just to answer it.  its to figure out why the question is being asked and propose to best possible solution to it. 

if i made a post about the best bridge to jump off to insure death would you simply respond with your personal preference or would you ask more questions. - yes thats extreme.  but when new posters here ask questions that show they dont even understand how mortgage paydown works it likely means they have not researched it enough to know if they should even be paying it down.

You're completely ignoring the risk-return trade-off between investing in the market and paying down a mortgage. As Lmoot pointed out, there is no one-size-fits-all answer to this despite your opinion to the contrary.


i'm not ignoring it ... its been discussed else where.  just pointing out the OP should look into it .  my statement came with a preface of low fixed rate in the US.  and seeing as OP is unaware of how paying down a mortgage works they are likely unaware of their inherent added risk.  show me a math equation where paying down a 3.25-5% 30 year fixed rate mortgage beat putting money in an IRA with vanguard. you cant find it b/c it doesnt exist.

I have shown you this equation multiple times, boarder42, yet you seem unwilling or unable to comprehend it.
Quantified Risk= Probability * Consequence.
You repeatedly ignore the consequence factor, likely because of your privileged upbringing. You cannot fathom the consequence of becoming homeless with your children if you would just ask dear old dad for a bridge loan (as you've stated in other threads).
If you really truly value efficiency of finance over emotion, then why don't you sell the boat you keep bragging about and put that money into the market?  Until you are willing to do that, you must accept that there is no single solution that fits everybody's situation.

Lmoot

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Re: The way mortgages work
« Reply #16 on: September 14, 2016, 09:15:13 PM »
OP has 26 posts on this site and may not actually understand the risk he is taking on and the added time to FIRE by paying down a mortgage.

second your thought that the money in tax advantaged accounts isnt accesible til 59.5 means you arent fully aware of how FIRE works.  90% of my money will be in tax advantaged accounts and i will retire at 37 and use this money.  see below.  in most cases even paying the 10% penalty carries a low tax burden not to mention the other 2 ways to avoid that penalty. 

http://www.madfientist.com/how-to-access-retirement-funds-early/#ck_modal2



the correct way to respond to any question is not just to answer it.  its to figure out why the question is being asked and propose to best possible solution to it. 

if i made a post about the best bridge to jump off to insure death would you simply respond with your personal preference or would you ask more questions. - yes thats extreme.  but when new posters here ask questions that show they dont even understand how mortgage paydown works it likely means they have not researched it enough to know if they should even be paying it down.

Regarding your link, method 1 guarantees you pay tax twice on the same contribution.

Method 2 looks like a minefield:
Cons
72(t) distributions usually require help from a tax professional to set up correctly.
You must continue withdrawals until standard retirement age, whether you need the money or not.
You must continue withdrawals, whether it makes sense to or not (which means you could be forced to sell when the markets are down).
If you stop withdrawals or withdraw the incorrect amount, you could be forced to pay a penalty on all 72(t) distributions you’ve received, even in previous years.

Umm, you have to sell even if the market is crappy? You might need to pay a tax professional to make sure you don't screw yourself. Retroactive penalties? Are you kidding me?

I'm not saying investing in the market doesn't have its merits, but lets not pretend it's the goat's oats every time; that calculated average growth in the market does not take into account the penalties, fees, restrictions, and the taxes associated with playing the game. Some people do not want to deal with all that financial gymnastics and prefer to keep it simple.

That is wonderful that you can retire at 37, but don't make the same mistake that other higher income earners make by inequitably attributing your ability to retire early to investment method, vs income/contribution. Cooking methods may vary, but the ingredients are the key players. Correlation is not causation and what not: your ability to retire at 37 probably has less to do with where you put your money, and more to do with the amount of contributions. If you can retire at 37 grossing less than $50k, just by riding the wave of the market, then color me impressed.

boarder42

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Re: The way mortgages work
« Reply #17 on: September 15, 2016, 05:25:20 AM »
It's widely accepted in the early retirement game that youre going to jump thru some tax loop holes to get to your money if you want to save as efficiently as possible. Are you an older person ?  Not really going for an early FIRE. Did you even read everything in the link.

In fire you're likely going to have to sell in a down market unless you extremely. Over save. The roth ladder is widely regarded as the best way to access funds but there are others.

Saving in tax deferred accounts greatly accelerates your time to fire.

So go ahead and save taxable funds when you aren't maxing all tax advantaged accounts just know youre increasing your time to fire. And the amount of money your hard earned dollars are making for you vs the govt.
http://www.madfientist.com/retire-even-earlier/

kpd905

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Re: The way mortgages work
« Reply #18 on: September 15, 2016, 05:38:36 AM »

Regarding your link, method 1 guarantees you pay tax twice on the same contribution.


You do not pay tax twice when using a Roth IRA conversion ladder.

boarder42

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Re: The way mortgages work
« Reply #19 on: September 15, 2016, 05:41:17 AM »

Regarding your link, method 1 guarantees you pay tax twice on the same contribution.


You do not pay tax twice when using a Roth IRA conversion ladder.

thanks missed that point they made up

Lmoot

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Re: The way mortgages work
« Reply #20 on: September 15, 2016, 07:12:41 AM »

Regarding your link, method 1 guarantees you pay tax twice on the same contribution.


You do not pay tax twice when using a Roth IRA conversion ladder.

thanks missed that point they made up

Funny you should say....I only came to the conclusion by reading the link you provided:

Cons
•You have to wait five years after executing the conversion to withdraw the money without penalty.
•You pay tax on the conversion five years before you can use the money so you lose out on the tax-free growth that money could have provided.

So either I am wrong (which I am fine with as I always welcome the opportunity to learn), or your source is wrong...which is just ironic.

bacchi

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Re: The way mortgages work
« Reply #21 on: September 15, 2016, 07:20:39 AM »

Regarding your link, method 1 guarantees you pay tax twice on the same contribution.


You do not pay tax twice when using a Roth IRA conversion ladder.

thanks missed that point they made up

Funny you should say....I only came to the conclusion by reading the link you provided:

Cons
•You have to wait five years after executing the conversion to withdraw the money without penalty.

Yep, thus the "ladder."

Quote
•You pay tax on the conversion five years before you can use the money so you lose out on the tax-free growth that money could have provided.

Because of deductions and exemptions, if you convert less than a certain amount, the conversion is tax free.

ender

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Re: The way mortgages work
« Reply #22 on: September 15, 2016, 07:23:32 AM »
Yeah, the whole point of the Roth conversion ladder is you are able to convert pretax money into posttax money slowly and in amounts such that you don't pay any income taxes (or minimal) on the conversions. Because you aren't working and have no regular income source.

That con is also misleading, because after the conversion, any growth that the converted money has is completely tax free, as it's now in a Roth account.

Lmoot

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Re: The way mortgages work
« Reply #23 on: September 15, 2016, 08:03:43 AM »
So you've got to maintain precision (hence the advice to consult a tax accountant). Got it. And some people don't want to deal with that crap. It's great that it's an option for those who do, but it won't necessarily be the best or most attractive option for everyone.

Lmoot

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Re: The way mortgages work
« Reply #24 on: September 15, 2016, 08:11:29 AM »
Are you an older person ?  Not really going for an early FIRE. Did you even read everything in the link.

Saving in tax deferred accounts greatly accelerates your time to fire.

So go ahead and save taxable funds when you aren't maxing all tax advantaged accounts just know youre increasing your time to fire. And the amount of money your hard earned dollars are making for you vs the govt.
http://www.madfientist.com/retire-even-earlier/

Are you an older person ?

If 32 is older



Not really going for an early FIRE

No. I'm going for career freedom. My goal is to be able to change to any career, preferably on a seasonal schedule, where even a minimal wage income, combined with retirement funds, pensions, savings, social security, and passive real estate income, is more than enough to support my expenses. And I plan to work intermittently for as long as my body and mind let me. See what I mean by you cannot blanket a solution without knowing somebody's goals? Furiously acquiring money for the first half of my life so that I don't have to earn money for the second half, has never appealed to me. I make sacrifices, sure, so that my choices and my lifestyle grows progressively better...but that's how I want it...progressively.


boarder42

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Re: The way mortgages work
« Reply #25 on: September 15, 2016, 08:16:52 AM »
great so your point is if you arent interested in FIRE none of this works for you .. thats a great opinion on a FIRE forum... haha.  but i'd still be willing to bet it does and you come out ahead but you're obviously not interested in retiring so not really sure what value your comments are providing in a forum full of people most looking to optimize their working years to retire and live off that money they saved.  and the roth ladder works really well for working intermittently.  its a super flexible option.  but if you're not about optimizing then sure i'll take your free tax dollars and put them towards my future healthcare and social security.

bacchi

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Re: The way mortgages work
« Reply #26 on: September 15, 2016, 08:18:40 AM »
So you've got to maintain precision (hence the advice to consult a tax accountant). Got it. And some people don't want to deal with that crap. It's great that it's an option for those who do, but it won't necessarily be the best or most attractive option for everyone.

You must be confusing the Roth conversion with the 72(t). The conversion is an easy formula and there are no onerous penalties for getting it wrong, unlike the 72(t).

It's as easy as finding out the current year's exemptions and standard deductions and converting that amount, less any income. At worst, you'd have to buy Turbotax/Taxcut in December and plug in some prelim numbers -- hiring an accountant for this would be serious overkill.


Lmoot

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Re: The way mortgages work
« Reply #27 on: September 15, 2016, 09:32:50 AM »
great so your point is if you arent interested in FIRE none of this works for you .. thats a great opinion on a FIRE forum... haha.  but i'd still be willing to bet it does and you come out ahead but you're obviously not interested in retiring so not really sure what value your comments are providing in a forum full of people most looking to optimize their working years to retire and live off that money they saved.  and the roth ladder works really well for working intermittently.  its a super flexible option.  but if you're not about optimizing then sure i'll take your free tax dollars and put them towards my future healthcare and social security.

Oh come on. Don't play the "you don't belong here" card. There are probably close to 10k users here and if you can't conceive that some of them just might not share your exact goal of retiring at 37, then I really hope you don't have a professional position of consulting or advising due to such an extremely self-centric tendency. I personally share a lot of "mustachianesque" values, regardless of the exact age I want to "retire".

I didn't say I don't plan on having the ability to retire early if I want or need to. I don't need to retire extremely early. It's not a race for me and therefore I am not going to put myself through a rigamaroo. Just because you are not optimizing to the infinite place, does not mean you aren't still optimizing. I didn't realize the hardfast rule of the forum to was FIRE ASAP at all cost; I was under the assumption that people could choose when they wanted to retire, then map out a plan that allowed them to retire by that time. If they are on schedule, then why is it so important to you that they are not doing more? or "the most"?

Also, I view the ability to have any career I want, with no care about income above min wage, a type of Financial Freedom. It may not be your goal of financial freedom, but again, yours is not the end-all-be-all, even on a forum like this.

There is nothing wrong with offering an alternative to educate people (though in this case the OP was educated and you just assumed they weren't), but in any case, if someone has all of the cards but decides to still go with a different play for reasons not possibly known by you, it's a little condescending to continue to state that you know what's best for them without knowing little else.
« Last Edit: September 15, 2016, 11:03:01 AM by Lmoot »

ender

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Re: The way mortgages work
« Reply #28 on: September 15, 2016, 09:51:46 AM »
So you've got to maintain precision (hence the advice to consult a tax accountant). Got it. And some people don't want to deal with that crap. It's great that it's an option for those who do, but it won't necessarily be the best or most attractive option for everyone.

Most people who retire early have taken these matters into their own hands. It's why they are here.

If you want to take the "easy but not optimized" route that's fine. But some of us are learning as much as we can about how to optimize our finances in order to maximize our ability to FIRE .

Knowing how federal income taxes work seems like a basic life skill to an aspiring FIRE person.


afuera

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Re: The way mortgages work
« Reply #29 on: September 15, 2016, 10:21:24 AM »
I have what may be a very elementary question:

When paying mortgage, a certain amount of each monthly payment goes towards principle and a certain amount goes towards interest. At the start of loan it is weighted more heavily towards interest and gradually over time the weighting shifts, increasing the amount going to principle and decreasing the amount going to interest.

If one were to prepay the mortgage, which is to say make an additional payment to be used towards the principle, would this cause the weighting on the next month to shift more towards principle than it would have had the extra payment not been made? Or does the weighting staying the same through the course of the loan, but prepaying would simply shortens the end date?
Thanks for asking this.  I had the same question. 

Lmoot

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Re: The way mortgages work
« Reply #30 on: September 15, 2016, 10:51:32 AM »
So you've got to maintain precision (hence the advice to consult a tax accountant). Got it. And some people don't want to deal with that crap. It's great that it's an option for those who do, but it won't necessarily be the best or most attractive option for everyone.

Most people who retire early have taken these matters into their own hands. It's why they are here.

If you want to take the "easy but not optimized" route that's fine. But some of us are learning as much as we can about how to optimize our finances in order to maximize our ability to FIRE .

Knowing how federal income taxes work seems like a basic life skill to an aspiring FIRE person.

"If you want to take the "easy but not optimized" route that's fine."

I know it's fine :) It's not me you have to convince.

Also, for some people doing what is suggested above is optimal (it is optimal for a specific goal). And don't conflate "optimal" with "not optimized". You can still optimize using different methods...there is a whole lotta in between ya know.

Also, if you don't earn much (like myself) leveraging would actually likely be the OPTIMAL way to go in terms of return. No amount of loopholing will turn low contributions into massive return. So for me, no....what is touted as the traditional method around here is very likely less optimal than my real estate investing just because I can borrow much more than I can contribute.
« Last Edit: September 15, 2016, 11:16:40 AM by Lmoot »

J_Stache

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Re: The way mortgages work
« Reply #31 on: September 15, 2016, 10:53:01 AM »
I will try to clarify amortization in as simple a form as possible. 
1. Amortization means paying off debt in fixed payments over time. 
2. Each payment has an interest portion (equal to Outstanding Balance*Interest Rate Per Period [1]). 
3. Remainder of Payment goes to principle.  (This is why paying extra toward the beginning of a loan is much more effective than paying extra at the end of the loan). 
4. Extra payments reduce principle, which reduces OB (Outstanding Balance), which increased portion of future payments going towards principle.

[1] Int Rate Per Period is different than APR.
6.55% (.0655) APR =Monthly Rate*12. 
So Monthly Rate= .5458% (.005458). 
Effective Annual Rate, which is different from APR is [(1+int rate)^12]-1 = [1.005458^12]-1= 0.0675 or 6.75% (.0675) Effective Annual Rate.

ender

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Re: The way mortgages work
« Reply #32 on: September 15, 2016, 11:35:43 AM »
Also, if you don't earn much (like myself) leveraging would actually likely be the OPTIMAL way to go in terms of return. No amount of loopholing will turn low contributions into massive return. So for me, no....what is touted as the traditional method around here is very likely less optimal than my real estate investing just because I can borrow much more than I can contribute.

The less you earn, the more important making optimal tax decisions is throughout your career. The difference between smart, good, and oops decisions is literally years of your career you have (or don't have)  to work. Every % you save via intelligent tax awareness is effectively more you invest. So saving 10% on taxes results in 10% more invested.



Prairie Stash

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Re: The way mortgages work
« Reply #33 on: September 15, 2016, 12:42:58 PM »
So

1. It's not weighted. You have more debt at the beginning which you are gradually paying down along with your interest costs. You are paying the same percent interest.

2.  You should be asking IF you should be paying down your mortgage and that answer is no if you have a low fixed rate mortgage. You're costing yourself a few years on FIRE and security once FIREd. 

looking at wow look how high the interest is now as a dollar amount is a very very poor way to analyze the cost/risk
PITI, from what I understand its optimal to get your mortgage value to less than 80% in the USA. In Canada once you hit the 80% value you get extra benefits, there's value in reaching the target. IF OP is at 83% and can reduce his mortgage insurance would you recommend investments still? Even if his mortgage insurance could be dropped and save those payments?

Nothing is black/white, there's always grey exceptions.

MrMoogle

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Re: The way mortgages work
« Reply #34 on: September 15, 2016, 01:11:26 PM »
great so your point is if you arent interested in FIRE none of this works for you .. thats a great opinion on a FIRE forum... haha.  but i'd still be willing to bet it does and you come out ahead but you're obviously not interested in retiring so not really sure what value your comments are providing in a forum full of people most looking to optimize their working years to retire and live off that money they saved.  and the roth ladder works really well for working intermittently.  its a super flexible option.  but if you're not about optimizing then sure i'll take your free tax dollars and put them towards my future healthcare and social security.

Oh come on. Don't play the "you don't belong here" card. There are probably close to 10k users here and if you can't conceive that some of them just might not share your exact goal of retiring at 37, then I really hope you don't have a professional position of consulting or advising due to such an extremely self-centric tendency. I personally share a lot of "mustachianesque" values, regardless of the exact age I want to "retire".
I disagree.  There are an infinite number of goals, and therefore an infinite number of "optimal."  Most forums limit themselves to specific purposes.  Don't go to a car forum to ask about FIRE,  unless your car has been in one.  This forum is mostly about the goal to FIRE.  If you have a different goal, it should be said up front.  With money decisions, the goal is very important and will send you down different paths.  There are certainly many details that work for ER that don't work as well for others.

Certainly you belong here, but you also have to be smart enough to figure out what works for you, when your goal does not meet most others. 

chesebert

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Re: The way mortgages work
« Reply #35 on: September 15, 2016, 01:25:56 PM »
I have what may be a very elementary question:

When paying mortgage, a certain amount of each monthly payment goes towards principle and a certain amount goes towards interest. At the start of loan it is weighted more heavily towards interest and gradually over time the weighting shifts, increasing the amount going to principle and decreasing the amount going to interest.

If one were to prepay the mortgage, which is to say make an additional payment to be used towards the principle, would this cause the weighting on the next month to shift more towards principle than it would have had the extra payment not been made? Or does the weighting staying the same through the course of the loan, but prepaying would simply shortens the end date?
1. Split between interest and principal with respect to your monthly payment would be different on a going-forward basis
2. Total monthly payable stays the same on a going-forward basis (i.e., you can still go into default/foreclosure if future monthly payments are in arears regardless of whether you have previously paid off any portion of the principal amount)
3. Total time to payoff decreases proportionally
4. Total amount interest payable throughout the term decreases proportionally
« Last Edit: September 15, 2016, 01:27:30 PM by chesebert »

Lmoot

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Re: The way mortgages work
« Reply #36 on: September 15, 2016, 01:36:33 PM »
great so your point is if you arent interested in FIRE none of this works for you .. thats a great opinion on a FIRE forum... haha.  but i'd still be willing to bet it does and you come out ahead but you're obviously not interested in retiring so not really sure what value your comments are providing in a forum full of people most looking to optimize their working years to retire and live off that money they saved.  and the roth ladder works really well for working intermittently.  its a super flexible option.  but if you're not about optimizing then sure i'll take your free tax dollars and put them towards my future healthcare and social security.

Oh come on. Don't play the "you don't belong here" card. There are probably close to 10k users here and if you can't conceive that some of them just might not share your exact goal of retiring at 37, then I really hope you don't have a professional position of consulting or advising due to such an extremely self-centric tendency. I personally share a lot of "mustachianesque" values, regardless of the exact age I want to "retire".
I disagree.  There are an infinite number of goals, and therefore an infinite number of "optimal."  Most forums limit themselves to specific purposes.  Don't go to a car forum to ask about FIRE,  unless your car has been in one.  This forum is mostly about the goal to FIRE.  If you have a different goal, it should be said up front.  With money decisions, the goal is very important and will send you down different paths.  There are certainly many details that work for ER that don't work as well for others.

Certainly you belong here, but you also have to be smart enough to figure out what works for you, when your goal does not meet most others.

I get where you are coming from (I don't think it applies here, but I get it). However the goal to retire ASAP is not stated anywhere on this forum or the blog as the goal that supercedes all other goals. In fact, in reading about MMM's journey to early retiring, it's all very relaxed and blasé:

"This was achieved not through luck or amazing skill, but simply by living a lifestyle about 50% less expensive than most of our peers and investing the surplus in very boring conservative Vanguard index funds and a rental house or two."

What if someone's goal is to be FIRE by 40? or 50? And they adjust their investment strategy accordingly? Are they not trying hard enough? Are they not aiming to be FIRE soon enough?

What about the PF golden rule of diversify? Many people can't afford to max out every tax-advantaged account every year, and even if they could, they couldn't do anything else. Well according to several posters above, this is the optimal way to do it. They imply that the OP/others are CHOOSING not to max out TAA before investing elsewhere. And that's simply not often the case. Many people can't afford to do that so they are left with the option of putting all of their eggs into one basket (which is not necessarily optimal IMO), or divvying up their investment strategy.


ender

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Re: The way mortgages work
« Reply #37 on: September 15, 2016, 04:24:02 PM »
What about the PF golden rule of diversify? Many people can't afford to max out every tax-advantaged account every year, and even if they could, they couldn't do anything else. Well according to several posters above, this is the optimal way to do it. They imply that the OP/others are CHOOSING not to max out TAA before investing elsewhere. And that's simply not often the case. Many people can't afford to do that so they are left with the option of putting all of their eggs into one basket (which is not necessarily optimal IMO), or divvying up their investment strategy.

This whole approach supports investing in TAA and not paying off a mortgage early.

Did you misword it?


LeRainDrop

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Re: The way mortgages work
« Reply #38 on: September 15, 2016, 04:34:59 PM »
Hm, I came here for the original question, but like 75% of the thread is just boarder42 and ender attacking Lmoot's financial plans, none of which has any bearing on the OP's question.  Cheers to the handful of people who gave thoughtful responses to the actual question.

ender

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Re: The way mortgages work
« Reply #39 on: September 15, 2016, 04:40:04 PM »
Hm, I came here for the original question, but like 75% of the thread is just boarder42 and ender attacking Lmoot's financial plans, none of which has any bearing on the OP's question.  Cheers to the handful of people who gave thoughtful responses to the actual question.

The question was answered in the first handful of posts.

I think it's important that on a forum dedicated to FIRE, that when someone makes recommendations/assertions based on misleading or faulty assumptions to at least attempt to dialog about the issue. Would you prefer that not happen?

I don't particularly care. If you'd prefer that those of us (such as boarder42 and myself) who care and want to FIRE as early as possible to stop sharing information and helping others to do so, let me know. It won't hurt my plans if people are dispensing misleading advice to others here.

boarder42

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Re: The way mortgages work
« Reply #40 on: September 15, 2016, 06:03:14 PM »
lmool yes leveraging yourself in real estate is a fantastic way to retire even earlier see AREBELPSY   ... but to make the statements your making with out a mindset towards your investment strategy is not productive and a non starter.  when anyone here says to max tax advantaged accounts its clear what their strategy is.. its not real estate.  and to remind myself of the title of this post its asking to pay down your mortgage which is the exact opposite of the leverage youre talking about ... so YOU yes YOU LMOOT should have recommended leveraging yourself and not paying down your mortgage instead ... cryptic hard to decifer comments saying its not best for everyone.  yeah no one strategy is best for everyone but many are best for most. 

bacchi

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Re: The way mortgages work
« Reply #41 on: September 15, 2016, 07:10:32 PM »
PITI, from what I understand its optimal to get your mortgage value to less than 80% in the USA. In Canada once you hit the 80% value you get extra benefits, there's value in reaching the target. IF OP is at 83% and can reduce his mortgage insurance would you recommend investments still? Even if his mortgage insurance could be dropped and save those payments?

Right, good point. Getting rid of PMI (Private Mortgage Insurance) is usually very important because it's usually very expensive.

frizzywhiskers

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Re: The way mortgages work
« Reply #42 on: September 15, 2016, 08:39:02 PM »
OP, I am in the midst of a major Mortgage payoff - also looking for career freedom and eventually FIRE.  This may be a little on the anal side (heh) but I have been tracking my mortgage payments/interest payments since day one.  So back to your original questions, it's super cool to watch the shift in interest payments.  I have attached the spreadsheet if you are interested.

MDM

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Re: The way mortgages work
« Reply #43 on: September 15, 2016, 09:44:36 PM »
Also, from http://forum.mrmoneymustache.com/mustachianism-around-the-web/amortization-schedule-calculator/msg1219175/#msg1219175:

1. Open a new sheet in Excel
2. Press the "sheet1" tab on the bottom with a right-click
3. "Insert" --> "Spreadsheet solutions" --> "Loan Amortization"