# truth about lump sum for my mortgage



## Jocose (Nov 12, 2012)

A year ago I took a mortgage for my house. 
Trying to be smart about my money and reading articles like this, I started to make lump sum payments in addition to my required payments. 
By the end of first year I got all excited thinking how much money I saved by dumping my extra cash into my mortgage.
Today I was bragging about it to my dad. He smiled and asked me to check 1 thing: find out how much money I did actually save, then subtract total of my lump sum from that amount.
I was shocked when I saw the result. It's negative! 

I don't actually save a penny on the total interest of my mortgage! In fact I pay more!
Yes my amortization period is shorter now, but only because I payed more money in my first year... My bank most love me: I took mortgage for 25 years, but will pay it back in 19. For them it'll be the same amount.

_Easy to check, for example here. 
Let's say:
Amortization Period 25 years,
Mortgage Amount $250000,
Interest Rate 2.7%,
Payment Frequency Monthly,
*Total Interest Cost will be $93,524.97*.

Now click on 'Add special payments': add Payment Period=1, Lump Sum=12000. 
Let's see what I've saved by throwing $12,000 in in my first year.
*Now Total Interest Cost will be $82,607.00 
PLUS $12,000 that I threw in!! 
It comes out as $94607 which is definitely more than $93,524.97.*

By the way in the article that I mentioned above, we read this
"By paying an extra $50 a month over the life of the mortgage, John would save over $14,000 and pay off the mortgage two and a half years sooner"
Haha! Do your math $50x12monthsx22.5years = $13500. John saved $14,000? Where? Where did he save it?
_

Please tell me where I'm wrong.


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## bgc_fan (Apr 5, 2009)

Jocose said:


> _Easy to check, for example here.
> Let's say:
> Amortization Period 25 years,
> Mortgage Amount $250000,
> ...


Where you are wrong is that the $12,000 is paid down on the principle. You can't consider that to be interest. Their calculation is correct as you are paying less interest in the long run. 

Consider this, that $12,000 in principle can be paid up front (as a lump sum as you did), or spread throughout the 25 years. The difference is that if you spread it out for the 25 years, you will be paying interest on that $12,000. Either way, you pay this $12,000, but by prepaying, you avoid the interest that would be accumulating on that sum.


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## Jocose (Nov 12, 2012)

bgc_fan said:


> Consider this, that $12,000 in principle can be paid up front (as a lump sum as you did), or spread throughout the 25 years. The difference is that if you spread it out for the 25 years, you will be paying interest on that $12,000. Either way, you pay this $12,000, but by prepaying, you avoid the interest that would be accumulating on that sum.


I don't think I understand what you are talking about
did you check it in a mortgage calculator?
there is *no interest that disappear with a lump sum of $12,000* 
so whether $12000 spread out for the 25 years or paid as a lump sum, the total amount to lender will be the same


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## crazyjackcsa (Aug 8, 2010)

Math isn't really your friend. Or your Dad's for that matter. Look at your first example: Total Interest Cost will be $93,524.97.

So that's the Total Interest Cost. Not your total payments which is where you are getting confused. That is strictly your interest payments on your principal.

Looking at your second example: Total Interest Cost will be $82,607.00. 

So, subtracting the two, the difference is $10,917.97. You just saved that in interest payments by reducing the principal. This is the key. Your principal just dropped by 12k. That money didn't disappear. You now owe $12,000 less on your house. ADDITIONALLY, you will save $11,000 over the life of the mortgage.


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## MoneyGal (Apr 24, 2009)

...waiting for the next post from OP...


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## bgc_fan (Apr 5, 2009)

Jocose said:


> I don't think I understand what you are talking about
> did you check it in a mortgage calculator?
> there is *no interest that disappear with a lump sum of $12,000*
> so whether $12000 spread out for the 25 years or paid as a lump sum, the total amount to lender will be the same


You may want to revisit that mortgage calculator and take a look at the bottom line of the Amortization Table. If you look at the very last line after the Payment Period #, there is a line that has Total. It includes the total of the payments, principle, and interest paid. 

Scenario 1 (No prepayment)
Totals	$343,524.97	$250,000.00	$93,524.97

Scenario 2 ($12,000 prepayment)
Totals	$332,607.00	$250,000.00	$82,607.00

Notice the difference in the total payments and interest paid between the two scenarios.


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## Jocose (Nov 12, 2012)

Ok, I didn't see that my $12,000 appear in the first line of principal.
I have to admit I was wrong. 
bgc_fan and crazyjackcsa thanks for your answers


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## jcgd (Oct 30, 2011)

I bet you feel relieved now.


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## Jocose (Nov 12, 2012)

jcgd said:


> I bet you feel relieved now.


100% ))


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## crazyjackcsa (Aug 8, 2010)

No big deal, it can seem confusing, that's for sure. Now you can tell your Dad he's wrong. I suggest starting with "Hey! Old Man! Where did you get your fancy book learnin'?" or something like that


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## Islenska (May 4, 2011)

On sort of a related issue does anyone know or run into the idea that banks do not want loans paid off early?

Years ago I paid off our mortgage (30%) remaining in one swoop and then a year later a fairly large personnel loan. (had a chunk of money that came in).

The Royal bank loans officer intimated quietly not to do that again. Being youngish and a bit paranoid I always wondered if I was on their "watch list". Probably my imagination was running overtime!


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## My Own Advisor (Sep 24, 2012)

That was funny @crazyjackcsa...


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## Sampson (Apr 3, 2009)

Islenska said:


> On sort of a related issue does anyone know or run into the idea that banks do not want loans paid off early?


This seems very intuitive no? Part of their argument could have been its effect on your credit rating (if you don't have other sources of credit), but It is very likely they just want to make more money.


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## Rusty O'Toole (Feb 1, 2012)

Islenska said:


> On sort of a related issue does anyone know or run into the idea that banks do not want loans paid off early?
> 
> Years ago I paid off our mortgage (30%) remaining in one swoop and then a year later a fairly large personnel loan. (had a chunk of money that came in).
> 
> The Royal bank loans officer intimated quietly not to do that again. Being youngish and a bit paranoid I always wondered if I was on their "watch list". Probably my imagination was running overtime!


They don't like it because now they have to go to the bother of lending that money out again. It may seem funny but they do not want the money back, they want it out earning interest. They want it back some day of course, just not too soon.

This is why they charge a penalty for paying off a mortgage early.

I don't think it hurts your credit rating. It should be the opposite. Maybe some banker or credit expert can chime in.

Let's just say it's a lot better for your credit to pay early than pay late.


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## Pennypincher (Dec 3, 2012)

I have a friend who is always in debt. She claims that it is "dangerous" to pay off your mortgage early and not have any other debt (which my spouse and I are about to do in half a year). She says that if we ever needed a loan quickly, we would have a hard time getting one as we would have not so great credit history.

I am not sure what we would need a loan for, as we have decent emergency savings. But I suppose if we decided to get an investment loan, would there be potential problems if we didn't have any debt that we were currently paying down? Especially if we didn't want to tie our loan to our home equity.

My friend thinks she is very financially responsible because although she has a huge mortgage and a not so huge income, she makes all her monthly minimum payments. She can probably get a bigger loan than I can.


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## MoneyGal (Apr 24, 2009)

My goodness. If one happened to prioritize paying down debt (AND BUILDING EQUITY), wherever would one get (SECURED) credit if one needed it? (HINT: YOUR FRIEND IS DRINKING SOME KIND OF WEIRD BANK KOOL-AID)


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## bgc_fan (Apr 5, 2009)

MoneyGal said:


> My goodness. If one happened to prioritize paying down debt (AND BUILDING EQUITY), wherever would one get (SECURED) credit if one needed it? (HINT: YOUR FRIEND IS DRINKING SOME KIND OF WEIRD BANK KOOL-AID)


It's not too different from the states where the sentiment is to keep a large mortgage because you can write off the interest from your taxes. Heaven forbid that you pay off the debt so you don't have to pay interest and then claim tax credit for it. I think that Americans are so tax adverse that they don't see the illogical thinking in that scenario, i.e. 
1. Pay $100 in interest
2. Get a tax deduction for a fraction of that (say marginal tax rate of 25%), save $25 in taxes
3. Profit??
So you are left with a net loss of $75, but at least you didn't give the government $25 of your hard earned money.


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## MoneyGal (Apr 24, 2009)

It's the cognitive leap that if mortgage debt is "good debt," then more "good debt" is a good thing. Total disordered thinking, kind of like bingeing on diet food.


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## Sampson (Apr 3, 2009)

While I believe that most are best off to focus on paying down their mortgages, and no doubt the financial industry has promoted that people keeps loans for long periods, but for an average joe, there certainly can be benefits to locking in and protecting against inflation, accessing capital for leveraged investing, and the forced 'savings' that paying a mortgage offers.

Obviously one has to be disciplined, but I have never seen anyone provide evidence that the average renter comes out on top because they are not servicing debt. Certainly buying a house and having access to secured credit most often results in over spending and using home equity on consumer purchases, but in the right hands, the leverage offered by a mortgage can result in quite significant financial advancement.


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## none (Jan 15, 2013)

...unless you bought a house in Toronto in 1989 -- then you were, and have been, totally screwed financially.

Buying at peak is silly no matter if you are investing in the stock market or in Real estate. There is a ton of evidence that Canada is at the top of the bubble which is a bout to deflate. Anyone who buys a house in the last 2 years and gets burned only have themselves to blame as all the warning signs are there.


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## Robillard (Apr 11, 2009)

Rusty O'Toole has it right. Banks (or whoever is holding your mortgage) don't like it when borrowers make prepayments. But they can live with it, since mortgages are often offloaded to investors.

You have to understand that any kind of investment that generates cash flows prior to maturity has some amount of reinvestment risk. Suppose you buy bonds with a coupon rate and yield to maturity of 5%. Your actual return on investment may turn out to be less than 5% if you cannot reinvest the coupon payments in something that generates at least a 5% return. In addition to the reinvestment risk, many mortgages allow the borrower to make prepayments, which from the investor/lender's perspective means that payments of principal can arrive at unexpected times. 

The prepayment problem is one reason why mortgages are often bundled together, securitised and sold to investors. Investment analysts have found that prepayment activity on mortgages can be predicted mathematically, to some extent, depending upon prevailing interest rates. Bundling mortgages together reduces the prepayment risk associated with an individual mortgage, since it is unlikely that all the mortgages in the bundle will be prepaid at the same time.


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