Saturday, May 21, 2005

There's more to it than sending extra money...


I wanted to share some information that I received in my email a couple of days ago. I was thinking of Brad , the unrepentant, as he and his wife are settling into their new house. With just a few dollars more anyone can work to pay down the principal on their homes. Take a look and see the correct way to do it.

Paying off mortgages and car loans fast requires a little more effort than simply sending extra money, as this client discovers...

A client writes:

"Hi Greg,
We have been paying a little extra on our house payment each month from the beginning of our loan, and we have paid half of the payment halfway through the month.

Right now our statement says that the next payment due date is November 2005.

If I don't make a house payment until November, will that work against us where the interest is concerned? We appreciate your advice!" -- Martha

Hi Martha,
No. You've already paid future interest... and that's a problem!

I don’t believe your mortgage company has applied your extra monies in your favor.

Since your statement says; "no payment due until November 2005,"

I believe your mortgage company is applying extra money to Future Payments instead of Current Principal.

That is, instead of shrinking your principal balance each time you paid extra money, thereby reducing your cost of interest each month and shortening your time to payoff, your mortgage company has "assumed" you intended to make Future Scheduled payments.

They have consumed practically 100% of your extra money for interest instead of applying 100% of your extra money to principal balance reduction.

To illustrate, assume your principal balance is $100,000 and your regular payment is $800 of which $700 is interest and $100 is principal.

In January you make a scheduled $800 payment. Your balance should decrease by $100 to $99,900.

In February you make another scheduled $800 payment. Your balance should decrease by $100 to $99,800. And so on...

Now, suppose in MARCH you send in an EXTRA $500 with your scheduled payment. This is what you want to happen...

Scheduled payment reduces balance by $100, as always.
New balance is $99,700.
EXTRA $500 reduces balance by $500.
New balance is $99,200!

You should start APRIL with a balance of $99,200 because you have PAID OFF more principal using your EXTRA $500. You don’t want your $500 to be considered a partial payment of your future APRIL scheduled payment!

If you’ve been sending in extra money for a while, each time you reach $800 they register another future monthly payment paid.

This is how your statement can read, "No payment due until November 2005."

I recommend a visit to your mortgage company to discuss re-allocating your extra payments to your principal balance and refunding the excess interest you paid against a balance which should have been declining. They may balk, but we’re talking about serious money. Your money!

The best procedure to rapidly pay off amortized debts, like mortgages and automobile loans, is to send two checks, one for your Scheduled payment and one for your EXTRA principal reduction. Attach a note
to your EXTRA principal reduction check stating, for "Principal Reduction Only!"

And even this may not work 100% of the time, so...

After your checks have cleared, VERIFY your mortgage balance to confirm proper application of your checks -- each month!

I know this can be a bit of a bother, but understand what's at stake. By paying off your mortgage 20 to 25 years early, you are costing your mortgage company hundreds of thousands of dollars. By the same token, you are earning hundreds of thousands of dollars! It's worth a few minutes of your time once a month.

Greg Moore is the Architect of the Debt Freedom System, 'DebtIntoWealth -- Lessons from My Journey to Debt Freedom." Check out Greg’s website at:
http://www.debtintowealth.com/debttrap.html for more information.

Also check out: www.bankrate.com/dls/news/debt/20050520a1.asp "Paying Ahead vs. Paying down principal on loan." Written by Steve Bucci of Bankrate.com





2 Comments:

At 9:58 PM, Blogger Brad Warbiany said...

Lucy,
They talked about this in The Automatic Millionaire, which I highly recommend. Sending an extra payment every year will reduce your total loan from 30 years to 22 years.

But he mentions that in most cases, you actually have to send a letter to the loan company to let them know that extra payments should be applied to principal rather than interest.

 
At 3:09 AM, Blogger Emran Hossen said...

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