Strategies for Mortgages

This month I would like to discuss mortgages and the benefit of extra principle payments – especially at the front end of the loan. As a bit of a personal background, I operated a real estate company for over 12 years that encompassed purchasing distressed properties then renovating them. After renovation the properties were bundled together in groups of 4 usually and sold to the end investor. The properties were a turnkey operation for the investor as they were all rented prior to closing. This was done in an area of ultra low market values to enable the bundling together for a still relatively low price for all 4 properties – usually in the neighborhood of 150 – 200K for all, or about $45,000 each. The rent to value ratio was very good in that each unit rented for approximately $800, or a total of about $3,200 per month. I was able to secure 90 – 95% financing for the investor mortgages through various mortgage firms I was affiliated with. The mortgage debt service was approximately $250 per month per property, add in taxes, insurance and pmi and the total liability per property was about $400 per month. This provided the investor with a net cash flow of about $400 per month per property for a total net of $1,600 per month. Needless to say the numbers worked out very good from a rent to value and capitalization rate standpoint. On a $15,000 down payment, the approximately $19,200 net per year profit paid back the investor’s down payment by the end of the first year. I closed approximately 300 properties during the 12-year timeframe.

I go through this long description only to say I learned quite a bit about the mortgage business and how it all works during that time. I am still amazed with some of the pilots I fly with plus others I come in contact with that do not realize they have the ability to pay down the principle early on their mortgages – an obvious benefit the mortgage companies would rather you not know.

For example, on a 300K, 30 year fixed mortgage at 5% APR the payment is equal to $1610.46. If you printed out the amortization table for all 360 payments (I’ve done the first 24 payments below) you have a breakdown of principle and interest on each payment. As you make your monthly payments and move down the table more of your payments get applied to principle and less to interest. In the very beginning of the loan, it is front end loaded with mostly interest, which means very little is actually going to pay down your loan – which is the principle part of each payment. You reach a point, beyond the half way point of the loan, where the principle amount is finally greater than the interest and from that point forward you are applying more of each month’s payment to principle therefore taking a bigger chunk out of the balance with each successive payment. If you make the minimum payments to the mortgage company over the 30 years on this loan, you wind up paying them back about $280,000 in interest only – almost 2 times the amount you originally borrowed!

Fortunately there is a solution to this unnecessary cost,assuming you have the cash flow to allow it. There are a few ways to accomplished this – one is sending an extra principle payment every year, another is bi-weekly payments and another I will detail below is to add up a certain number of principle payments and include it with your regular mortgage payment. Also, most mortgages now a days do not have any pre-payment penalty, so that is not a factor to consider. I’ll breakdown this hypothetical mortgage for 300K at 5% for 30 years below for the first 24 payments:

Payments | Principle | Interest | Balance

$1,610.46 | $360.46 | $1,250.00 | $299,639.54
$1,610.46 | $361.97 | $1,248.50 | $299,277.57
$1,610.46 | $363.48 | $1,246.99 | $298,914.09
$1,610.46 | $364.99 | $1,245.48 | $298,549.10
$1,610.46 | $366.51 | $1,243.95 | $298,182.59
$1,610.46 | $368.04 | $1,242.43 | $297,814.56
$1,610.46 | $369.57 | $1,240.89 | $297,444.99
$1,610.46 | $371.11 | $1,239.35 | $297,073.87
$1,610.46 | $372.66 | $1,237.81 | $296,701.22
$1,610.46 | $374.21 | $1,236.26 | $296,327.01
$1,610.46 | $375.77 | $1,234.70 | $295,951.24
$1,610.46 | $377.33 | $1,233.13 | $295,573.90
$1,610.46 | $378.91 | $1,231.56 | $295,195.00
$1,610.46 | $380.49 | $1,229.98 | $294,814.51
$1,610.46 | $382.07 | $1,228.39 | $294,432.44
$1,610.46 | $383.66 | $1,226.80 | $294,048.78
$1,610.46 | $385.26 | $1,225.20 | $293,663.52
$1,610.46 | $386.87 | $1,223.60 | $293,276.65
$1,610.46 | $388.48 | $1,221.99 | $292,888.17
$1,610.46 | $390.10 | $1,220.37 | $292,498.07
$1,610.46 | $391.72 | $1,218.74 | $292,106.35
$1,610.46 | $393.36 | $1,217.11 | $291,712.99
$1,610.46 | $394.99 | $1,215.47 | $291,318.00
$1,610.46 | $396.64 | $1,213.83 | $290,921.36

So, if you made your normal regular payments on this mortgage the first payment on the first month would be $1610.46. You principle balance would have gone down by $360.46 and the resulting balance would be $299.639.54. Then month 2 you would make the same minimum monthly payment and so one through the term of the loan or until you sold or refinanced the house. However, if your cash flow allowed, you can add up just the principle amounts on the next, let’s say, 3 payments. You would pay the regular payment of $1610.46 for the first payment and include an extra $1090.44 for principle reduction only (the next 3 monthly principle amounts – $361.97 + $363.48 + $364.99). Now when you arrive at month 2 of the loan, you have jumped down to payment # 5 on the amortization table and your balance at this point would be $298,549.10. You have erased from paying to the mortgage company all the applicable interest on payments 2, 3, and 4, thereby saving $3740.97 (the interest payments) for your investment of $1090.44 (the principle payments). You have also increased the principle amount of even your regular payment because you are further down the table. You may be able to pay the extra amount for more or less of the aggregate than the example I used, but the point is you can make the most aggressive attack on your principle at the beginning of any mortgage as they are all front end loaded with interest. Your goal is to arrive at the breakeven point on this mortgage – where more is being applied to principle on each payment. On this loan modeled that point would be payment # 194, which is more than 15 years into the loan. From that point on, you are paying more principle than interest on each payment. I am only illustrating this option of accelerated payment. There are other ways to accomplish the same goal, such as 1, or more, extra payment(s) per year, bi-weekly payments, etc. The point here is, if you have the means, you have many options that afford you the ability to build equity in your house faster and not pay such a large sum of interest to the mortgage company.