Mortgage Prepayment amortization examples needed

[sonnys]

Hello all,

I recently moved and took a 30 year mortgage on my primary residence.  I am saving and investing in stocks and real estate already and I just want to pay this off as part of my FIRE plan.  I recently read that simply making a prepayment on the principal for next month's mortgage payment can cut the schedule by almost half.  This is not referring to an extra payment, just a prepayment of the principal. 

Is this mathematically accurate?  I remember using an amortization calc and saw that making an extra payment would drop it from 30 years to 22 years.  How can making a prepayment of Principal (which is relatively small) make such a large impact?  I am not sure I understand this.....Is anyone using it?

Thanks,
Sonny

[Bobberth]

My favorite place to get mortgage calculators is http://www.mtgprofessor.com/calculators.htm

He's got a calculator for just about everything.

[sonnys]

Thank you Bob.  I can't seem to find a calc which can account for the increasing principal payments automatically.  I would have to essentially tell the calc the extra monthly payments on a year by year basis which is tedious.  Also, the book where I read this stated that this is not an extra payment, just a prepayment of next month's principal but the more I think about it the more it seems like an extra payment.  E.g. - let's say that my monthly payments are a $1,000 and the principal is roughly $200.  With the prepayment, I am going to pay $1,000 + $200 each month.  I think the book incorrectly stated that these are not extra payments.

[MarciaB]

I'm a hands on type of learner for this kind of stuff, so I would go and download the free Excel amortization spreadsheet:

http://www.vertex42.com/ExcelTemplates/loan-amortization-schedule.html

and then play with it. You could assume that the prepayment is just an additional payment of principal and see what happens. Do it only once and see how much interest that saves. Then do it two months in a row and see how much time gets cut off...rinse and repeat. Because there's a row for each month you can change the prepayment amounts, vary their frequency, and generally just do what you might actually do in real life (which is likely to be more hit and miss over the years).

I can't imagine that just paying the actual amount slightly early would cut the loan in half

[NoraLenderbee]

A good, clear mortgage calculator here (and free):
http://www.hughcalc.org/mort.php

You can enter prepayments and see the amortization.

[maizefolk]

By a prepayment, do you mean that you're paying the principal part of your payment a month earlier than you would otherwise would have? Or do you mean you make an additional prepayment equal to the principal portion of your payment? So if your mortgage payment is $700 ($500 interest/$200 principal) you'd pay $900 that month.

If it's the latter, it makes intuitive sense that it'd cut the timeline of your mortgage in half. Since you're paying twice the principal every month, you'll have payed the same total amount of principal in half as many monthly payments. The catch is that because you're making additional prepayments, the portion of your monthly payment going to principal will increase faster than it would otherwise. After 15 years you'll have almost no interest and almost entirely principal when you write your last $1400 check to close out the mortgage (which is the same principal/interest split you'd have on your final $700 mortgage payment if you took the whole 30 years to pay off your mortgage).

It's a good strategy to adopt if you expect either your income or your frugality muscles to to grow significantly over the next 15 years.

[Beach_Stache]

I love using Karl's Mortgage Calculator and have the app on my phone and love playing with it!
https://www.drcalculator.com/mortgage/
If you click on the "Extra" button you can input your extra payments and at what month, and you can put in many different values.  In my example, I have 3 kids who were all in daycare last year.  My oldest is now in the 1st grade so we aren't paying for school anymore!  So we can afford $350 extra each month, starting at month 21 of our mortgage.  The next kid we can put $350 more towards the mortgage at month 52, then the final one at month 88.  I love seeing how just a bit extra at different times can shorten the span of your mortgage!  So you can see how putting that little extra from your raise or from cutting your cable or whatever extra you can save will shorten your mortgage!  If I keep on my current planned schedule we'll cut our mortgage from a 30 year down to a 16 year!

[zephyr911]

Thank you Bob.  I can't seem to find a calc which can account for the increasing principal payments automatically.  I would have to essentially tell the calc the extra monthly payments on a year by year basis which is tedious.  Also, the book where I read this stated that this is not an extra payment, just a prepayment of next month's principal but the more I think about it the more it seems like an extra payment.  E.g. - let's say that my monthly payments are a $1,000 and the principal is roughly $200.  With the prepayment, I am going to pay $1,000 + $200 each month.  I think the book incorrectly stated that these are not extra payments.

Have you ever considered just making your own?
It's a great way to get really familiar with the subject. I occasionally use free online tools, but for maximum control, there's nothing like DIY. Control every aspect of the equations, get the result you want.

[dandarc]

Thank you Bob.  I can't seem to find a calc which can account for the increasing principal payments automatically.  I would have to essentially tell the calc the extra monthly payments on a year by year basis which is tedious.  Also, the book where I read this stated that this is not an extra payment, just a prepayment of next month's principal but the more I think about it the more it seems like an extra payment.  E.g. - let's say that my monthly payments are a $1,000 and the principal is roughly $200.  With the prepayment, I am going to pay $1,000 + $200 each month.  I think the book incorrectly stated that these are not extra payments.

Have you ever considered just making your own?
It's a great way to get really familiar with the subject. I occasionally use free online tools, but for maximum control, there's nothing like DIY. Control every aspect of the equations, get the result you want.

Exactly - great opportunity to learn some spreadsheet skills.

I once put together a sheet that tracked 6 or 7 loans I had at the time and amortized everything and would properly 'snowball' the payment as they paid off.  Was kind of disappointed when I paid the last one off because I had put so much effort into that sheet.  But some of the stuff learned in putting it together was very useful for other things.  Array formulas and what not.

[sonnys]

@maizeman - The book that I read this in Money - Master the game from Tony Robbins.  It has a lot of good information but I am confused about this specific part.  He said that you only prepay the principal from the next month, but it is a prepayment, not additional payment.  Now that part confuses me.  As an example - My first year's payments are $1,000 a month with $200 principal and $800 interest.  If I don't do any prepayment then I will be paying $1,000 x 12 for a total of $12,00.  If I make prepayments, then it would be:

Jan - $1,000 + $200 = $1,200
Feb - $1,200
March - $1,200 and so on for a total of $1,200 x 12 = $14,400

So I am paying $2,400 extra with the prepayment method.  I would consider those extra payments.

Also, I think I am going to spend some time and make my own sheet so thank you for the encouragement. 

Sonny.

[K-ice]

I'm a hands on type of learner for this kind of stuff, so I would go and download the free Excel amortization spreadsheet:

http://www.vertex42.com/ExcelTemplates/loan-amortization-schedule.html

and then play with it.

I use the above spread sheet & love it.

Below in the yellow colum you could just make the extra payment = to the principal pmt. for that month, drag the cell down for every month until the end of the mtg.

I think that is what you are trying to do.

The odd thing with this method, as someone already mentioned, is that your extra pmt increases every month so this may be hard to budget for. Also, your bank may not let you do such an odd pmt plan.

I might figure out what the average extra pmt is for the year and apply a consistently every month.

Figure this out again for year two & repeat.

Regardless of what method you take, have fun paying off your mortgage faster.

[sonnys]

@k-ice - thanks for that calc, I will look into it now but I just wanted to ask you and everyone if my assumption from the previous post are correct.  Essentially I am paying more per month and year correct?  In the end, its simple math - pay more upfront so you pay less overall interest.  There is no "magic trick" as the book made it sound. 

[maizefolk]

@maizeman - The book that I read this in Money - Master the game from Tony Robbins.  It has a lot of good information but I am confused about this specific part.  He said that you only prepay the principal from the next month, but it is a prepayment, not additional payment.  Now that part confuses me.  As an example - My first year's payments are $1,000 a month with $200 principal and $800 interest.  If I don't do any prepayment then I will be paying $1,000 x 12 for a total of $12,00.  If I make prepayments, then it would be:

Jan - $1,000 + $200 = $1,200
Feb - $1,200
March - $1,200 and so on for a total of $1,200 x 12 = $14,400

So I am paying $2,400 extra with the prepayment method.  I would consider those extra payments.

Also, I think I am going to spend some time and make my own sheet so thank you for the encouragement. 

Sonny.

Sonny, you are right, that is confusingly worded. Maybe he's saying using "pre-payment" to mean additional payments which are less than a full monthly payment? Whenever I put a bit extra in my monthly mortgage check they always ask me if I'd like to use the additional funds as an "extra principal payment" which certainly sounds like an extra payment to me.

Good luck with the spreadsheet, I agree with the others here that building one yourself is the best way to get a real understanding of the situation. But do remember you'll have to recalculate the principal portion of each monthly payment because the fact that you payed $1200 in January means that the principal portion of the payment for March (which you'll be adding to your February payment) will be slightly larger than it was originally going to be. Very small effect initially, but within a couple of years it'll be having a big effect on how much you're paying each month.

[sonnys]

Yes, that is the tricky part.  I hope there is a formula that I can use so that it takes the value from the principal field and adds it.  I don't have excel so I am going to try to use Google docs.  Another point would be that the extra payments would make much larger towards the end of the loan and then the whole debate of whether making extra payments is a smart move at all considering the opportunity cost - could I get more than the 3.8% that I am paying for my mortgage?

[gardeningandgreen]

I work at a bank and also have a mortgage of my own. The opportunity cost may not be there with such low interest rates. But I do know for myself and for many others paying it off early is a great security. As far as payments go our bank (and with most banks from what I understand) the payment would be due on say the 1st but you aren't assessed the late payment penalty until the 15th. You are paying interest on that full amount until you make a payment. So in reality if you are paying your principal early you would actually be paying less in interest. I wouldn't say half as much but it would lower your interest if you pay it earlier in the month. As far as my mortgage goes we get paid biweekly so put half the payment +$50(which isn't much but our payments are low) into a savings account. At the end of the month we make the mortgage payment. This allows us to have the same amount from every paycheck go towards our mortgage and we are making a full extra payment each year on principal. This from my calculations will make our mortgage go from a 30 year mortgage to a 22 year mortgage. We will most likely pay it off long before then or move but it is a start.

[dandarc]

Glad you know why gardening - a lot of people think paying the mortgage biweekly knocks that much time off because of compounding.  The month to month or week to week compounding is a very small factor - paying 8 or 9% more to the mortgage annually is what does it.