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Author: yFool One star, 50 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 126963  
Subject: mortgage interest question, basic Date: 4/16/2000 3:13 PM
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hiya

I have a fixed rate loan with "no prepayment penalties"

My understanding is that loan payments are scheduled such that early payments are almost entirely interest while late payments are almost entirely principal. If I decide to pay down or refinance a portion of the principal, how is interest calculated?

It seems as though my interest would have to be calculated as if I were paying/will be paying equal proportions of principal and interest at each payment, then the total interest calculated, then the new total interest redistributed according to some sort of interest-up-front distribution (amortization?).

Is this the case?

Or is the interest paid up front water under the bridge? In which case I'd view it as a substantial prepayment penalty.

thanks

y
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Author: JABoa Big gold star, 5000 posts Feste Award Nominee! Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 10640 of 126963
Subject: Re: mortgage interest question, basic Date: 4/16/2000 6:33 PM
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Please go read the Math board, starting at the beginning. Disclosure, it's sort of my board. I think your notion is correct, but it's sort of murky as you phrase it. Suppose you owe $200,000 at 8%. Then your interest this month will be $200,000 x .08/12. You will also pay down some principal which will depend on the term of the loan. Now suppose your Aunt Zelda dies and leaves you $50,000, even though you never liked her. You apply that $50,000 to the principal. Next month, you will owe $150,000 x .08/12 in interest. Actually it will be a bit less because of the principal you paid down on the previous month, so maybe it will actually be $149,850 or something.

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Author: JAFO31 Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 10642 of 126963
Subject: Re: mortgage interest question, basic Date: 4/16/2000 7:27 PM
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yFool: "I have a fixed rate loan with "no prepayment penalties"

My understanding is that loan payments are scheduled such that early payments are almost entirely interest while late payments are almost entirely principal. If I decide to pay down or refinance a portion of the principal, how is interest calculated?

It seems as though my interest would have to be calculated as if I were paying/will be paying equal proportions of principal and interest at each payment, then the total interest calculated, then the new total interest redistributed according to some sort of interest-up-front distribution (amortization?).

Is this the case?

Or is the interest paid up front water under the bridge? In which case I'd view it as a substantial prepayment penalty."


I am having a difficult time understanding your true question, so I will ramble a bit and submit; if that is not adequate, repost and ask again; I will be willing to try.

JABoa knows his math, so he might have already answered your question, but I will come at it in a different way.

My first suggestion is to construct an amortization spreadsheet; it is not that hard and I and several other posters have expounded in more detail in earlier posts. A board search should locate them.

Interest on a mortgage loan is typically paid in arrears and on the outstanding principal balance for the particular month. An amortization schedule for a fixed rate loan is nothing other than a calculation (assuming no prepayments) of the constant monthly payment amount that will bring the mortgage to zero at the end of the stated term. [NOTE - payments must be made in whole cents, so it is not always possible to bring it exactly to zero at the end of ther term; in this case, the small extra balance is due with the final payment and you want the payment amount that brings it as close to zero without going negative at the end of ther term, and to which if you increased it by one cent, would generate a negative number at the term.

Interest already paid is water under the bridge, and it is not a penalty. If you make a prepayment of principal, all payments going forward will be in the same amount, but their application will be recalculated to reflect that less interest is due per month after the prepayment (as a result of the prepayment) than would have otherwise been due, resulting in a larger portion of any particular subsequent payment being applied to principal than if prepayment had not been made.

Hope this helps. Regards, JAFO

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Author: JDOyster Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 10647 of 126963
Subject: Re: mortgage interest question, basic Date: 4/17/2000 1:14 PM
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Or is the interest paid up front water under the bridge? In which case I'd view it as a substantial prepayment penalty.

Already-paid interest is water under the bridge, but I don't consider it a prepayment penalty.

Think of it like this: when you take out a loan, you are renting money. A lender's price (interest) for renting out a dollar for a month is, say, 8%/12 = $0.00667. The first month, you rented $200,000; the rental fee is $1333.33. You pay the rental fee plus a little principal; the next month, you rent a little less money, so the fee is a little lower. And so on.

Remember, the money for your loan didn't come out of a vacuum...there is a lender somewhere whose bank account was depleted by your loan...

Good Luck,
JDOyster

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Author: yFool One star, 50 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 10659 of 126963
Subject: Re: mortgage interest question, basic Date: 4/17/2000 8:16 PM
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it all clicked in place.
thanks for your replies.
for some reason, i thought that payments and interest would each be held constant in a loan.
silly me--it's the interest rate and the sum of interest and principal that's constant. therefore the principal must be quite low in the beginning.
it's just sort of frightening seeing how high those initial interest payments are...

thanks

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Author: SacramentoGary One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 10669 of 126963
Subject: Re: mortgage interest question, basic Date: 4/18/2000 4:46 PM
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This thread appears to be finished, but if you'll permit me one more thought? This same principle that has been discussed is also the reason why, if you do choose to pay "extra" toward a mortgage, it is more efficient to do so in the beginning years. In the beginning, the principle-interest ratio is weighted quite heavily towards the interest. Somewhere past the half way point of the mortgage, the balance shifts towards the principle side (JABoa/Math Board confirm timeline?). This is why, if you do choose to pay additional payments towards your mortgage, they will have a greater impact in the early years.

Gary

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Author: kitshef Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 12461 of 126963
Subject: Re: mortgage interest question, basic Date: 7/6/2000 9:03 AM
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Responding to the mortgage prepayment thread (see last reply, Gary's below)

So, just so I'm completely clear on this; If I pay more than is due this month, with the extra going to pay off principle:
1) My monthly payments will not change
2) A higher proportion of my future payments will go to principle
3) Therefore I will build equity faster
4) I will pay less in interest over the life of the mortgage
5) I will make fewer payments over the life of the mortgage.

Is that all correct?

-Kit


[This thread appears to be finished, but if you'll permit me one more thought? This same principle that has been discussed is also the reason why, if you do choose to pay "extra" toward a mortgage, it is more efficient to do so in the beginning years. In the beginning, the principle-interest ratio is weighted quite heavily towards the interest. Somewhere past the half way point of the mortgage, the balance shifts towards the principle side (JABoa/Math Board confirm timeline?). This is why, if you do choose to pay additional payments towards your mortgage, they will have a greater impact in the early years.

Gary]

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Author: JABoa Big gold star, 5000 posts Feste Award Nominee! Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 12463 of 126963
Subject: Re: mortgage interest question, basic Date: 7/6/2000 9:28 AM
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In response to Kit's #12461, the answer to 2) through 4) is Yes. The answer to 1) and 5) is also Yes provided you have a fixed. If you have a variable, your payments will be recalculated every year (or 3 years or whatever the adjustment period is) to reflect the new interest rate and any extra payments you might have made. But the amortization term is assumed the same. So suppose you take out a 1 year variable loan for $100,000 with a 30 year schedule. After 6 years, your Uncle Fester dies and leaves you $90,000, which you apply to the principal. Then your next adjustment will give you a payment that amortizes the remaining balance, which is likely $94,000 - $90,000 = $4000, over 24 years. The $94,000, which is a number I made up, reflects reduction in principal through the first 6 years.

The formula for the remaining balance P(n) after n payments of Q on an original balance of P, at an interest rate of i per compounding period, is

P(n) = (P - Q/i)*(1 + i)^n + Q/i.

Here, if your rate were 8% per annum, say, and payments are monthly, then i would be .08/12.

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