A Speedy Mortgage Payoff Can Create Some Confusion

Question: I thought I saw on TV, a while back, a way to accelerate the payoff on your home mortgage: (A) pay this month’s principal and interest and, at the same time, (B) pay the next month’s principal. By doing this I thought I heard that you now eliminated the interest for next month, and have reduced your principal balance by that amount.

My savings bank said “No!” Am I wrong? For instance, at the beginning of March, $398.68 of my $427.79 payment is going to interest and $29.11 is going to principal. At the beginning of April, $398.46 is going to interest and $29.33 is going to principal and my principal balance is $51,691.78. If, March 1, I add $29.33 (the principal for April) to my regular payment, for a total of $457.12, shouldn’t this reduce the (principal) balance by $398.46? If you use this in your column and I am wrong, please don’t use my name!--B.M.

Answer: I hate to be the one who tells you, and I certainly won’t use your name, but you and the bank are both technically right and wrong at the same time. You are reducing the principal amount owed by the amount of each prepayment, true enough, but it does nothing about reducing the amount owed each month on principal. If you’d care to withdraw the question this might be a logical time to do it before things get any more confusing.

This is an old device for accelerating the payoff of a mortgage, but it is still a little tricky to explain. On a fixed-rate mortgage, as you know, your monthly payment for principal and interest remains constant for the life of the mortgage (commonly 30 years).

Anything extra that is impounded for insurance and taxes can, of course, fluctuate yearly. But, while the monthly payment for P/I remains fixed, the percentage going to reduce the principal and the percentage going to the lender in the form of interest changes every month. And, for a depressingly long time, the lion’s share each month is going to interest, and only a fraction of it is going to reduce your principal.

In March, less than 7% of your payment (actually, 6.8%) is going to reduce your debt, and the other 93% or so is going to the lender. In April, you will be comforted to hear, a full 6.85% of each month’s payment is going to the reduction of principal, so we have to take the optimistic position that this is progress of a sort. What really discourages most home buyers, though, is the knowledge that--on a 30-year mortgage--you’re about 26 years down the road before those monthly payments start breaking 50/50 between principal and interest. At that point (Why not? The lender’s already got back more than twice the amount you borrowed), the shoe is on the other foot, and the percentage going to principal begins accelerating rapidly until, at year 30, the principal and interest are reduced to zero.

The theory behind this business of paying your normal payment on month No. 1 and adding to it the principal-only payment due on month No. 2 is that each such prepayment shaves exactly one month off the life of the mortgage. If you faithfully do this every single month you cut the payoff of a 30-year (360 months) mortgage down to 15 years (180 months) and save a gigantic amount of interest in doing so.

There are really only two things wrong with this sort of acceleration. One is that you have to have a printout of your entire 360-month amortization schedule (although most lenders will supply this as a courtesy), and it’s pretty easy to get confused.

The other is that, sooner or later--along about the eighth or ninth year (comparable to the 16th or 18th year on a conventional amortization)--those next-month-principal payments have stopped being a minor matter of $30 or $40 extra per month and are requiring an additional $200 or $300 a month.

A far simpler way to accomplish the same thing, and the one generally recommended by lenders, is to buy a paperback copy of already-prepared payoff schedules covering mortgages of any duration--from one year up to 406--at all interest rates and for all sizes of mortgages, and pay a fixed monthly, additional amount required to pay the mortgage off in any time frame with which you feel comfortable.

In your case, for example, according to the amortization schedule you included, you have a $52,000, 30-year mortgage at 9.25%. And, according to my copy of “Consumer Guide to Mortgage Payments” (Financial Publishing Co., 82 Brookline Ave., Boston, Mass.), your payments are (within a few cents), indeed, $427.79.

Now, flipping to the page covering the same size mortgage and the same interest rate, but running down the 15-year payoff line (instead of 30), we find that it would require $535.19 a month to cut your mortgage in half--$107.40 more than you are paying now. But without the hassle of having to add some new, differing figure each month.