By John D. Behle
Should you get a fifteen or a 30 year
mortgage? What about a bi-weekly payment plan?
Should I double up my payments or add extra
These are questions that millions ask and only
a few have answers to - most of which are wrong.
Sometimes the answers come from some staff
reporter at a newspaper or someone with some
expensive program to sell. Another problem is
that they answer a question without the proper
Size Does Not Fit All
No one can answer these questions without
first asking one. The question is what is the
best "safe rate" of return you can get
with your money.
Paying extra principle payments on your
mortgage is a way to invest money at the rate of
return of the interest rate of your mortgage. If
you are paying 9% on your mortgage, then any
extra principle payments are invested at that
rate. Is that the best rate you can get? Are you
in a position to invest the money. Extra money
paid on a loan is sunk, you can not get it back
easily and inexpensively. If there is no way that
you will need the money back and feel this is
your best rate, then it may not be a bad deal.
Provided it is a "safe" rate.
Away from the Ethically Disoriented
It isn't necessarily safe if you are giving it
to a third party besides your mortgage company.
Fraud or mismanagement can mean it may not get to
your mortgage company and you are out the money.
There are many cases where this has happened. My
recommendation is never to give it to a third
party. Work directly with your mortgage company.
On almost every loan you can make extra
principle payments or raise your payment at any
time. Even if there is a "pre-payment
penalty" it usually provides that you can
pay no more than 20% of the outstanding balance
each year. This gives you a plenty of room to
play. You do not need permission from your
lender, though cooperation is helpful. They may
have certain policies you need to know.
Crystal Ball May Cracked
You do not know what the future holds in the
world or your own life. Always commit to the
longest time period on loan repayment as possible.
It is a simple calculation to decide how much
extra to pay on a 30 year loan
to pay it off in 15 years. For example, let's
look at a $50,000 thirty year
loan at 9%. The payment would be
$402.31 per month.
$50,000 9% 360 months $402.31
$50,000 9% 180 months $507.13
An increase in the payment of $104.82
shortens the loan by one half.
It is a mistaken assumption to think you would
have to double your loan payment to pay your loan
off in half the time. If you doubled the payment
to $804.62, the loan would
actually pay of in 7 years (83.98
You don't know when or if an extra 100 dollars
may be needed. If you commit to a 30 year loan,
you can always begin paying off on a 15 year
schedule or any one you choose. If times grow
hard, you can back off to the original period.
Having a higher payment on a loan can also
make a property less desirable and salable to
someone else. In addition, high payments can
lessen the cash flow of a rental unit and it's
resulting value. A single family home may become
a rental later or if not, other potential buyers
may find the payments too high. Do not commit to
shorter time periods, but pay a loan off early if
it makes sense for you.
Most of my students would find a 9% rate way
too low to invest in. Investing in paper can
achieve safe rates of return up in the 14 to 24
percent range. In that case, it makes much more
sense to invest money at that higher rate. The
results are far more impressive in the long run.
After seeing this, many investors take larger
loans against their properties and invest the
cash in the higher rates provided by real estate
paper. The investors end up tens to hundreds of
thousands of dollars ahead when it is all over.
The person that really benefits is on the
other side of the fence. Let's look at how a
private mortgage holder might benefit from
increased principle payments. We'll use the same $50,000
loan mentioned above and assume it was purchased
at a 15% yield.
$50,000 9% 360 $402.31
$31,817 15% 360 $402.31
At a 15 year repayment schedule,
the payment is higher and the value of the note
is higher at the same 15% yield.
The yield has increased based on the price we
paid for the mortgage. Line 1 shows the new
payment based on 15 years.
Line 2 shows what the note is worth at a 15%
yield. Line 3 shows what the new yield is now
that the mortgage has been restructured.
$50,000 at 9% for 180 months = $507.13
$36,234 at 15% yield 180 $507.13
$31,817 17.77% 180 $507.13
It would be possible to buy this note for $31,817,
share the principle of accelerated mortgage
reduction with the payor and then turn around and
sell it at the same yield you bought it for and
still make a profit of $4417.
By having a shortened term, the mortgage is
more valuable and is actually more salable also.
Many mortgage buyers do not like long term paper.
The same mortgage buyer that turned down the note
previously might now buy it because of the
shorter term. The payor of the note, who probably
hasn't a clue how to get a higher rate of return
than 9% is also far better off with the mortgage
Saving $15,000 on a $10,000
How about a real attractive offer for someone
paying on a note. Over the course of 30
years an incredible amount of interest is paid on
a mortgage. Let's look at a way to save half of
the interest almost painlessly. This involves a $10
dollar per year increase in the monthly
payment. First the original note and it's
purchase price at a 15% yield.
$10,000 10% 360 $87.76
$ 6,940 15% 360 $87.76
Raise the payment $10 per
year and the loan will pay off totally in 9
years and 9 months. Over the
life of the loan, this will save the payor $14,976.86
in interest. (The original loan pays out $21,593.60
The yield on our investment raises to 18.42%
and the value of the note raises by over $1,000
Some may have already jumped ahead and
concluded that neither of these transactions
requires that you own the mortgage. In fact, most
of the ways to improve mortgages do not require
that you own them or at least own them for long
to realize tremendous profits.
It is a shame to hear all the transactions
where potential mortgage buyers pass up mortgages
for a few dollars in price or because they do not
have sufficient financing. You should explore
some of the options by talking to the payor on
the note. Sometimes the notes that are the least
marketable are the easiest to improve. What you
have that many of the institutions and
individuals out there sometimes lack is a
creative mind that explores alternatives and
options. Behind most problems lies a profit.
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