Amortization and Princple Payments

[travellinmike]

This is not exactly investment related but I feel safe posting it to the General Real Estate Discussion category.

A few years ago I got into it with the "customer service" rep at the mortgage company of my old house. She insisted that any additional principal paid would be applied to the end of the loan.

I was asking for an amortization schedule so I could make additional principal payments which would be equal to the principal amount for the next 1,2,or more periods. Depending on extra cash on hand at that time. My understanding is that the monthly principal and interest breakdown of a mortgage loan amortization is based on the outstanding principal amount. Therefore let me run through the following scenario:

- Jan. make regularly scheduled mortgage payment.
- Feb. make regularly scheduled payment, and using seperate checks send the principal amounts for the Mar, Apr, & May payments
- Mar. make regularly scheduled payment using the June coupon.
To my thinking this would be correct because based on the previous principal payments the June payment is the correct one since that is in sync the outstanding principal amount based on the amortization schedule.
- Apr. make regular payment using the July coupon and using seperate checks send principal amounts for Aug, Sep, Oct
- May make regular payment using the Nov coupon
Again because this is next based on the amortization

I was told that this is not how they do things and that any additional principal payments would be applied to the end of the loan.

Her scenario...
- Jan make regular payment
- Feb make regular payment & send in extra principal (say I send in equal to the next three months principal amount)
- Mar make regular March payment
Here is where I think she is wrong as technically it is not the march payment. Based on the amortization which is calculated based on the outstanding principal amount it should be the June payment (3 months ahead)

She then got onto how the loan would need to be re-amortized which sounded like alot of double talk. I could tell I was getting nowhere and hung up.

Obviously if this is true it is advantageous to the mortgage company as many fewer payments would be knocked off when the principal amount is $500 a month at the end of the loan vs $100 a month at the beginning of the loan. Therefore lots more interest money generated for the bank.

Am I correct or not?

This may be why my current mortgage company sends monthly statements instead of a coupon book.

Thanks and sorry if this is off topic.
Mike

[dealmaker]

AFAIK, youi're correct. Most (all?) conforming loans use the same software for calculating, and the interest is CALCULATED ON THE AMOUNT BORROWED. As the amount borrowed decreases, the subsequent amount applied to principle increases.

She probably didn't know.

dealmaker

[OKRICHLAND]

Hello guys,
OKRICHLAND here.
I can see very clearly the point you are making although, I have never
heard of a mortgage being calculated that way.
As I am not a loan officer and only know a little of how they work.
I hope that I am not to far off base here.

In the loan agreement that you signed at your closing,
it states that you are agreed to pay such and such amount on time every month until your loan is paid off.
This means that $500 is due in Jan and $500 in Feb, so-on and so-on.
You can pay $500 in advance (Full months payment do for that month) on each month and it will count for that month
how ever many months you choose.

You do have the option of refusing to the monthly payment -to- balance ratio
at your closing although, I think you would simply be without a house if that were the case. (You are just one out of thousands of applicants).
No skin off of their backs.

If they re-amortized every time someone made an advanced payment
witch changed the interest on the current balance, everyone's processing rates and fees would soar astronomically and it would turn out to be the same
in the end as it is now, concerning how much money you end up paying in all together.

Think of it in tax terms.
We can pay into your (IRS) account each month until you have reached your total amount due at the end of the year, or you can pay a 15% tax on everything that you buy in the store throughout the year and totally do away with the IRS but either way, the government is going to get their money.

Same thing with underwriters (Banks).
they are going to make their money either from your interest payments
or from your processing fees.
Either way, they are going to maintain the tallest buildings in every city you can imagine.

Now lets bring the investor into the scenario,
this way the topic will stay on subject.

I have always tried to stay at least two or three months ahead on all of my dwellings.
This way, I am not pulling my hair out if something were to happen to me or one of my buildings were to become vacant for some reason.

If you pay all of Jan, Feb and March (Full required Payments on the coupons) all at once in Jan, then you can rest at ease Knowing that you don't owe anything until April.

That's just the way the system works friend. :smile:
Added principal payments will always apply to the end payment.
That is the way that our banks prevail here in these GREAT United States
and around the world.

Hope I said all that as not to confuse you. :cool:

Dave

[dealmaker]

Well I'm not a loan officer either, in fact I haven't been a borrower on a mortgage for about 10 years. That said, I do know how to read an amortization schedule, and when I did have loans I always paid as much as I could as early as I could.

When you pay in an extra $50 per month it may not be real noticeable. On a $100K mortgage @ 8% paying $100 extra in month ONE drops the balance on the loan in month ONE HUNDRED TWENTY not by $100, but by $200. Paying an extra $10,000 in month ONE drops the month ONE HUNDRED TWENTY by $20,000! This is the power of COMPOUNDING INTEREST, but instead of accelerating the growth of your savings it's accelerating the decline of your debt, which is accelerating the decline of the bank's earnings.

This is why doubling your payment doesn't drop a 30 to a 15 year loan but to about a 13 year loan. Consumer magazines show these things from time to time.

You can check this for yourself if you have Excel or any other amortization schedule on your computer.

This is why Lord Maynard Keynes called compound interest one of the greatest inventions of mankind!

dealmaker

[dealmaker]

Whoops, after I wrote my last answer I thought about it a bit, and then re-read the ORIGINAL QUESTION. I think OKRICHLAND and I have gotten a bit twisted up.

Paying June July and August principle in May doesn't mean that your next payment isn't due until September. It also doesn't mean that you use September's coupon in June. It is SHORTENING the total length of your loan however. It's just not cutting it out of the middle.

I hope this ends some of the confusion.

You had said in your original post that you were talking to the
"customer service" rep at the lender. Hmmm, that would be the girl sitting at the desk where you ask for the forms and she hands them to you.

Heck I once had an "airline reservation" rep tell me that the reason a return flight was longer than an outgoing flight was because the return flight was "with the rotation of the earth" and the outgoing flight wasn't. Hmmm, the earth rotates at about 1,000 mph. If that were the case you couldn't walk from the back of the plane to the front while it's in flight. If you missed this one go back and repeat your high school physics course.

dealmaker

[DionEvalueMortgage]

First and foremost the lady you spoke to is RIGHT, I know you don't want to hear that but it is true.

Amortization is the repayment of a balance with in a specified amount of time based on a specified interest calculating both amounts of applied principle and interest.

Now let's take the traditional 30 year fixed rate mortgage, you know, the one loan that everyone thinks is the best program to be because my rate is locked and will never change and it is the safest.

The loan's math is done before you sign your paperwork, you are assigned 359 payments at a certain amount and 1 payment a couple dollars less than the other payment. The amoritzation schedule shows how much of each payment dollar amount is applied to principle and how much is applied to interest. Banks are not silly, they apply 80% (gerenal percentage not meant as true math percentage) of your payment towards the payment of the INTEREST not the principle. If you actually look at the amoritzation schedule you will see your principle payments and your interest payments do not become even for about 21 YEARS. Wow, that means you don't really start to make an impact on your PRINCIPLE until over HALF of the life of your loan is done and gone!

Because of this schedule banks take any dollar amount above and beyond the monthly payment and apply it to the end. The schedule works backwards. For instance if you apply just an extra $100 dollars each month you will have knocked off about 6 to 9 YEARS of the life of your mortgage. Now the amortization schedule DOES NOT change you don't start appling any great percentage of payments toward PRINCIPLE sooner than the schedule allows. The loan is just what you purchased a FIXED mortgage!

Most lenders will not allow EARLY or ADVANCED payments just because of the way they internally process your payment. You think your doing the right thing paying in advance 3 extra payments however, you still have to make March's payment in March. Your mortgage is ALWAYS paid in the REAR.

For instance, in Febuary you are paying for January's interest. Mortgages are the OPPOSITE of rental payments. As a landlord you charge your tenants for the term in which they are about to live. Mortgage is INTEREST which can not come due until is has happened. The Mortgage company can not charge interest for a period of time that has not happened.

Now, in an ARM, you know the type of mortgage all of our fathers, grandfathers and great grandfathers told us to fear! Because it's ADJUSTABLE. Well, adjustable rate mortgages have different amortization periods which means that principle paid down will directly affect your payment. For instance, in an extreme schedule you can get a bi-weekly amoritzation which means your loan is calculated and "re-calculated" every two weeks. This will allow the monies applied to work harder against principle, pay the mortgage down much faster. This is also why Greenspan made the adverse statement a couple of months ago ".....if americans where to have utilized Adjustable Rate Mortgages they would have saved hundereds of thousands of dollars opposed to Fixed Rate mortgages."

I think that should give you some info to swallow .....ask more questions if needed. I am here! :SM083:

[David Leach]

Mike,

I have been a mortgage broker for 10 years.

The lender is correct. Any "principle" payments are applied to the back end of the loan, thus reducing the term of your mortgage.

It's still worthwhile because you can reduce the length of your mortgage, thus saving you tens of thousands of dollars in interest (we have offered programs that do this for years), but it doesn't mean you "skip" payments of interest as your scenario would do.

I hope this helps.