Reducing total interest paid to your 30 year mortgage

[Hoan Thai]

I just got back from day 2 of the Rich Dad seminar taught by Elite Legacy Education. Our instructor Trevor Evans showed us what they call "Double Principal" payments. This is NOT the same as paying two mortgage payments. The premise behind it is that you pay your regular mortgage payment (principal + interest) and you include next month's PRINCIPAL amount. If you pay the principal payment at the beginning of the month you don't get charged with the interest you typically would. If you simply sent in a check and tell them to apply it to principal you will NOT get the same result because you will still be charged the interest in the second month. Your additional payment must match the principal amount of the next month or they won't know what to do with the money. To get that amount you have to create the amortization schedule and skip every other line (diagram below). This is huge if you really understand the concept. The down side is your monthly payment is larger and gets significantly larger as the time goes on because of the flip flop of principal to interest. I found a website who called it modulating payments. 

Here is their explanation of it 

"At the beginning of the loan we owe the most, thus the interest payment we owe is the highest, so the amount of the monthly payment that goes to principal is the lowest. Indeed, in Month 1, next month's principal payment (Month 2) on a 30 year at 6% on $200,000 is just $200.10.

So we are budgeted for $1,688 (the 15 year amount), but let's consider that we pay only the minimum due plus next month's principal: $1,199 + $200 = $1,399. We're under budget!

Now Month 2 arrives. But we've already paid that month's principal. You can just cross a line through that month—interest and all. We would have owed $999 in interest for that month, but because we paid that month's principal just one month early, that $999 in interest is completely wiped out. Zero. We spent $200 one month early and saved $999. That's a good deal.

It is important to note that the $999 savings is only realized, non-inflation adjusted, over the full scheduled term of the loan (30 years). If we pay off the loan early and exit the game we won't see the entire savings. We may think that if we pay $200 thirty days early, then we save only 1/2% of $200 or $1. That is the case if we repay the entire loan at the end of that month and then call the whole thing "quits." But for each month we do not pay back the entire loan, the savings accrue. By paying the $200 thirty days early, the entire loan payment schedule shifts forward one month—so now we will be paid off in 359 months instead of 360 months, etc., etc. That is why in Tip Number Two we think in terms of our total savings, over an entire life's payment span of 15 to 30 years, regardless of the number of mortgages."

I hope someone finds real benefit with this. I know I found it nifty. I also figured out how to calculate it in excel if anyone is interested.

[Olivia C.]

This is very interesting!  I'm going to study your link.

Thanks!

[Ned Carey]

Guru Gobledygook, Presuming your mortgage allows prepayment of principal, You can pay any amount towards principal and it will affect the entire amortizations schedule. There is absolutely no magic in paying exactly the amount of principal due in the following payment. 

[Hoan Thai]

@Ned Carey paying toward the principal versus this strategy is different. Read it closely. Supposedly this cuts out the next month's interest payment. It's what they taught, not something I've done, but I wanted to share. 

[Wayne Brooks]

Joan, Ned is right. We knew all about this 30 years ago. There is no magic the "new innovative spin" they put on it. It's really very simple.....interest is applied every month to your Outstanding Balance. The less outstanding, the less interest charged that month, therefore the more of your payment that goes to principle, which in reality just moves you further along on your amortization schedule. And make no mistake.....paying anything extra toward principle does do Exactly the same thing as paying exactly one month's principle. You and the other people there just didn't know better. And yes, I understand exactly what you were saying, but there is no difference. Next thing you know, they'll being selling a program that predicts what direction the sun will rise in.

[Wayne Brooks]

To clarify it better maybe, when you make that extra $200 principle payment you are Not saving the $999 interest for that month; you will save 4% On That $200, each month for the life of the loan

[Hoan Thai]

I'm glad I posted. I will play around with my Amort schedule in excel and check out the difference, or lack there of. Thanks guys for the clarity. 

[Thomas S.]

What is the point in dumping cash into a rental property mortgage. The idea is to get a mortgage at the lowest rate possible. stretch it out as long as possible and have your tenants pay it off while providing you positive cash flow. In addition you hope to realise appreciation which does not change with dumping money onto a mortgage. Think about your ROI.

It also does not, contrary to appearances, increase cash flow on a property.

As others have stated a mortgage is where cash goes to die.

[David Dachtera]

There actually is another way to do this. It has to do with using a non-amortized (simple or compound interest) type of account to pay off the amortized loan. It's the basis of the claims you've seen about paying off a 30-year home loan in around seven years.

I don't have the full details on it, or I'd post something more cogent. I have seen the numbers and I understand why it works, I just don't have the nuts and bolts of it.

In a COBOL programming class many years ago, the class material provided the loan amortization formula and it was up to us to write the code to produce an amortization schedule. Wish I still had that code.

From what I do remember, it's rather more complicated than the more simple "average daily balance" calculation of a non-amortized revolving credit account.

Anyway, that's the basis of debt acceleration. It works because by paying down big chunks of principal the total term of the loan is reduced which, in turn, reduces the total interest paid. You can see that on the amortization schedule the lender provided at closing.

I did find a YouTube link to a webinar about it. It's not short - it's an hour and 36 minutes, but even so, it does NOT spend the whole time selling. It's all info up until about the hour and six minute mark or so.

Hope this helps...

David J Dachtera

[Ned Carey]

@David Dachtera I figured this would get around to the pay off your mortgage in 7 years scam. I wondered it the original pitch @Hoan Thai heard was a set up for selling this.  Yes there were some minor advantages to be had by using a second mortgage with a lower interest rate, the float on your account and moving money around from one account to the other but it was a complex scheme with not a lot of advantage. 

Most people selling it could not even explain where the savings was coming from. The whole thing was based on having a lot of unused money in your checking account. If you didn't have that, the plan didn't work. What they failed to tell anybody is if you had a 100K mortgage. The only way you could pay it off was by paying at least 100K in seven years.

[David Dachtera]

@Ned Carey,

Although, as you know if you watched the video, it's not a scam. It's probably more the exception than the rule, but the numbers presented back up the claim and illustrate how to do it. It's very real and entirely possible. Most folks are likely to take longer than seven years given the current economy and the toll it has taken on many households. 12 to 15 years (roughly half of a 30-year term) is probably more realistic for most folks.

The video does not recommend using a second-lien (HELOC) type of account, though I suppose that might work if the interest rate is advantageous, rather it recommends an unsecured line of credit. Being a revolving line, the history it builds becomes an advantage in your overall credit history. Being unsecured makes it a positive addition to your types of credit (part of the score calculation in most models). After paying down a couple of "chunks" as the video calls them, I suppose a HELOC with a low utilization might be useful to offset the impact of the "New Checkbook" account on overall credit utilization as the balance fluctuates (as you pay big "chunks" toward the mortgage).

Also, I think you're putting too much focus on the "seven years" thing. Time is not the point, interest reduction by reducing the number of payments is the point. Instead of paying $230K on an initial loan balance of $100K after 30 years for example, the point is to aim for paying more like $130K (no, I didn't work that out on a calculator - it's a guess). THAT is where the savings comes from.

...and yes, the "doesn't work for everyone" part comes from the assumption that your monthly expenses are less than half of your take-home pay for the month. I covered that in my first paragraph in this post.

The whole technique is focused on doing exactly what you said in your last two sentences. So, I don't a problem.

David J Dachtera