Dear
Marie: As an attorney, I'm a little confused by your recent column
on mortgage prepayments. If I keep prepaying, do I ever have to pay any
interest?
You
are not the only one who has asked this question, so let me run through
the process again. Prepayment is legal and it does allow
you to avoid some major
interest payments, but oh, yes, you do have to pay interest. Just remember
that as long as you pay off any part of the principal before
the due date, you don't
have to pay interest on those portions prepaid. For instance, if you decide
to pay off the entire loan tomorrow, obviously, you wouldn't
expect to pay 30 years
of interest as well.
First,
let me show you a typical amortization chart for a 30 year, $100,000
loan
at 8.0% interest: (NOTE  the
monthly payments shown below do not include taxes and insurance escrow
amounts)
Mortgage Amortization Schedule
Pmt
No. 
Monthly
Payment 
Principal 
Interest 
Loan
Balance 
1 
$733.76 
$
67.09 
$
666.67 
$
99,932.91 
2 
$733.76 
$67.54 
$
666.22 
$
99,865.37 
3 
$733.76 
$
67.99 
$
665.77 
$
99,797.38 
4 
$733.76 
$68.44 
$
665.32 

When
you sign the note/mortgage, you are obligated to make 360 payments
to the lender. You can make those payments monthly for the next 30
years, in
which case,
your payment will always include accrued interest on the unpaid balance
of the loan, and you will have paid nearly $164,000
in interest alone. Or you can prepay some of the
principal
and avoid a lot of those interest charges.
Here's
the trick to prepayments: Make payment #1 of $733.66 which is the
principal payment plus accrued interest. At the same time, include
a separate
check, marked Extra Principal Payment #2 for $67.54. You do not have
to include interest on this payment because you are paying it in advance.
Next
month, make your regular payment of $733.76 which is now Payment #3
and at the
same time, include a separate check marked Extra Principal Payment
#4 for the principal portion of 68.44.

At
this point you have lived in the house for two months and made four
payments totalling
$1603.5.0 Under the traditional method of paying, you would have paid
out $2935.04 over four months to accomplish the same thing. In both
situations, your equity buildup
(principal repayment) is $364.64. However, by prepaying, you've
saved $1331.54 of interest.
Even
if you plan to live in your house just a few years, you'll realize
a savings and
a return on your investment. As you make payments, more money goes
to paying the principal. Thus, it's to your advantage to advance into
the payment schedule as quickly as possible in order to maximize the
effectiveness of your regular monthly payment. Remember,
you must always make that regular monthly payment of $733.76.
More
than 90% of the real estate loans out there allow proper prepayment.
Notice that
I said "proper prepayment." Lenders have options which
they can exercise to their benefit if you don't clearly indicate how
to apply the extra money. Obviously, it is to your benefit to prepay
on the frontend, not the back end of the loan.
Three Rules
 You must write
out 2 checks. Label one as "regular payment" and the other
as "extra
principal," (otherwise your lender might credit the additional
amount to your escrow account).
 You must pay in advance. So, if your regular payment is due on the
1st of the month, get in the habit of mailing your payments about the
25th of the preceding month.
 You must keep copies
of your checks for proof. Be sure to verify
the lender's principal balance at least once per year. If your bank
does not return cancelled checks you may need to open a new account
that does.
The days of borrowing
heavily are over. Paying off the mortgage loan not only reduces your
indebtedness but it also increases your net worth.
Marie
S. Spodek, DREI, GRI is a highly regarded real estate
educator and author. Her seminars have been attended by thousands throughout
the U.S. 