pay more principal or take more cash flow?

Question

I just made my first mortgage payment and am having some serious sticker shock when looking at the interest.

why is it almost all interest? I cash flow very well on this, so could definitely afford to pay more towards principle but I am trying to live off of the cash Flow..

I am confused what is best here

Brad L. · Answer

Each month, the amount going towards interest will decrease and the amount going towards principal will increase. Once you get to the end of the loan term the payments will be almost entirely principal with very little interest. Did your lender give you an amortization schedule with your closing documents? This would show month-by-month how the breakdown between principal and interest changes.

Riaz Gillani · Answer

Why is it almost all interest .... Mortgage interest is the interest you pay on your loan. We know this. It is based on the interest rate agreed to at the time you sign your contract. The interest compounds, which means the balance of your loan is based on the principal plus any accumulated interest.

What not everyone know is that our mortgage payments primarily go toward interest in the initial stage, with a small amount of principal included. This is a process lenders call amortization. It helps them with ensuring a return on their money even if the borrower repays the loan early or makes additional payments.

The point at which you begin paying more principal than interest is known as the tipping point. This period of your loan depends on your interest rate and your loan term. So someone with a 30-year loan at a fixed rate of 6% will hit their tipping point no more than 16 years or so into their loan. Having a lower rate will get them to this point faster.

Ben Zimmerman · Answer

I think there's some misinformation here.  Mortgages use simple interest, not compound interest and can be verified with a quick google search of "are mortgages simple or compound interest".  You are paying off the previous months interest balance in full when you make your next mortgage payment, so there is no possible way for this interest to compound since the interest is paid in full each month.  Compound interest means earning interest on your interest.  If the full interest balance is paid each month, it can't grow and compound.  The only way for interest to compound in a mortgage is if you fail to make your required monthly payments in which case foreclosure is in your near future.  As long as you make your required monthly payments, the interest is simple interest.  The reason that a large portion of your money initially goes towards interest in the beginning years, is because its during those years that you owe the most money.  Interest owed is based on the interest rate and the loan balance, so as the loan balance decreases over time as you repay the loan, the amount of money you owe in interest each month naturally begins to decrease and more and more of your fixed monthly payment begins applying towards the balance as opposed to interest.  Amortized loans have absolutely nothing to do with lenders ensuring they get a return on their money even if you repay the loan early.  Early in the loan you owe more money, and therefore pay more interest, there's nothing magical about it.  As for if you should repay the loan faster that's up to you, your goals, and your risk tolerance levels.  However from a strictly mathematical standpoint it rarely makes sense to do so.  Lets assume your mortgage interest rate is 5%.  Since mortgage interest is tax deductible, you aren't really paying the full 5%.  If you're in a hypothetical 20% tax bracket, you would effectively be paying only 4% interest on the mortgage (pay 5%, but get 20% of that back in tax refunds).  If instead you simply invested that money in something generic like index funds, the long term historical rate of return is 10% annually, less any taxes which at worst will be 20% for long term gains means you effectively earned 8%.

So would you rather save 4% interest, or earn 8% interest?

While the short term stock market can be volatile meaning you aren't guaranteed those rates of returns, over the course of a few decades (the time to repay a mortgage), the law of averages tend to work themselves out and you can be relatively confident that you will have earned something close to 10% annually pre tax over that timeframe.  As this money grows for multiple decades while you repay your mortgage, there is a massive difference in the amount of money you have by effectively earning 8% after tax, versus save 4% after tax by repaying your loan faster.

Play with a mortgage calculator that allows you to put in extra payments into the calculation such as the one linked above.  On a hypothetical 300k loan at 5% interest, if you put an extra $500 per month towards the payment, you will repay the loan in 216 months, which is 18 years.  However if you had instead taken that $500 and invested it at 10% annually, after 18 years you would still owe $174,125 on your mortgage, however your investment portfolio would have grown in value to $288,199 which means you made an extra $114,000 by NOT repaying your loan and simply investing the profits instead.  If we reinvest that money into something more lucrative like investing back into more real estate projects as opposed to simply buying index funds, the numbers start to become astronomical.

Eliott Elias · Answer

Depends on your goals. Do you plan on continuing to invest and build a large portfolio or want to have 5 properties paid off that you can live off of?

Theresa Harris · Answer

Look up payment schedules and breakdowns.  At the beginning as others said, most of the money goes to interest.  Near the end, most goes to the principal.  If you do extra payments, it will save you money.  There are online calculators that show you what happens if you do extra payments and how much you save.

Whether to pay it down or not is a personal choice. What are your goals-short term and long term?  If you want to have your mortgage paid off when you retire, so you have more cash flow to live off, then do it.  But also figure out how much you are paying and if you invested that money elsewhere, how much would you make?

Bill B. · Answer

How would you like them to charge you interest? Any other way they get hosed unless the force you to carry the loan for the entire term or have a pre-payment penalty for cancelling before the end.  This method is the best possible for the borrower.

If you have money sitting in the bank earning 0.01% then sure you can send it towards the loan and your interest portion will go down for the entire length of the loan. Using your example above. If you send an extra $360 give or take (any computer or app or banker can give you an amortization table for this loan.) will eliminate the last payment of $2759 for principle and interest. You will save over $2400 by giving them $360 today. If you keep the loan until the end.

Nick Belsky · Answer

@Stefanie Bergmann

I am going to echo my man @Riaz Gillani here. Any loan you do will likely have this wonderful thing called compounding interest.  You can look at any amortization schedule to see how your payment is broken down each month over the entirety of your loan.  Even when you buy a car, notice how much faster the principal balance drops each month as you get closer and closer to paying it off.  You don't really notice too much changing each month until you are over 1/2 way through the term though...

Throw an example into this amortization schedule and expand it to explore.  Its a great way to understand how they work and why.

https://www.bankrate.com/mortg...

Cheers!

Matthew Irish-Jones · Answer

@Stefanie Bergmann banks are smart.  They get paid up front.  You pay off your Principal last.

If you are cash flowing you should not really care that the interest is Front loaded… your tenants are paying it, not you.

Conner Olsen · Answer

@Stefanie Bergmann depends what your short-term goals and long-term goals are. If you want to buy more properties sooner I'd save the money and use that to buy another property. If you want this house to be paid off in 20 years and be a 'retirement fund' of sorts, then pay it off sooner. Every dollar you put in to pay down the principal of the house cannot be accessed unless you sell the house or get more debt so it's important to know your priorities.

Tanh Truong · Answer

I would live off the cash flow and let the rents pay the mortgage. In the beginning the interest is always higher than the principal.

pay more principal or take more cash flow?

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