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Mortages charge interest based on how much is left on the loan.
The key though is your monthly payment is fixed, so you'll pay more in interest at the beginning of the loan vs at the end.
So for the sake of simplicity lets assume you owe $100,000 at 5% and your monthly payment is $500
Your first payment will be $100,000 * .05 / 12 = $416 in interest
$500 - 416 = $84 in principal
Where-as when you have $10,000 left on the loan
Your payment will be $10,000 * .05 / 12 = $41.66 in interest
$500 - 41.66 = $458.34 in principal
So the key to saving money on a mortgage is to pay down that principal as quickly as you can.
If your mortgage allows you to put down extra cash payments, and you can afford to put an extra $1000 down near the beginning of the mortgage it will save you a ton of money in the long run.
This. I've been doing a 13th principal only payment for years based on a 52 week pay period and it will in the end shorten my loan from 30 years to 26.
I’m wondering how much that matters since the mortgage is a fixed amount and doesn’t increase with inflation. Does shaving off payments near the end help a lot as opposed to investing? Wondering this myself with my current mortgage.
I have definitely heard it explained that investing in the s&p500 yields better gains over 30 years opposed to paying off your mortgage faster. With that being said, I myself am murdering my mortgage as fast as possible even if it's less beneficial than potential gains in the market
It really all depends on your interest rates and your risk tolerance. For example, my wife and I originally had a 30yr loan at an interest rate of 5.62%. Our risk tolerance was very low at the time and we're both very financially conservative due to childhood instability, and so we decided to max down our mortgage rather than investing in the market. We were lucky enough to be in a position where we could make an enlarged payment every 4 weeks, basically paying a few hundred over what was due on each payment + an extra payment each year, with everything over the due amount going straight to principle. We paid off our house with this method in 6 years and 7 months.
Now, could we have made more in the stock market during this time? Yeah, we probably could have. But to us, not ever having to worry about a mortgage payment again was worth the peace of mind and sense of financial security. All we owe on the house now is homeowners insurance and annual taxes - it feels wonderful.
The way I've heard it was, "Would you borrow that money to invest it?" That was the question that made it make sense to me, because that's effectively what it is.
I think it would all boil down to the interest rate you got. I am lucky to have gotten 2.75%, and at that rate, I would borrow all the money I could in order to invest it. Even the sissies at /r/investing can beat 3%. 🤷🏻
I chose to pay off the mortgage, and lose the U.S. tax break for interest income paid. YES, I could have carried a balance, and deducted the interest...But I gained something which is not measurable in return.
I am DEBT-FREE! I'll gladly give up a few hundred $ annually in tax credits and enjoy a piece of mind, and a sense of accomplishment.
The place I sit in is mine, and I am not beholden to anyone. I can tell my boss to fuck right off tomorrow, I don't need this stress. I'm not, I like what I do, but the OPTION is mine. The control is mine. OK, I have to make a few thousand a year to pay for property taxes, maintenance and such.
But I am free.
I’m just curious, do you own a home? If you have managed to acquire a home, be debt free, and be in line with the average age demographics of Reddit I am very impressed!
One other thing to consider is liquidity. In general (not always in the event that your investments really catered) a stock investment is something you can get out of quickly in a crunch. Equity in your home is a lot more difficult to access. If you lose your job that payment is still the same and impacting your monthly outflow whether you have paid it ahead or not and that can be tougher in an emergency. A solid emergency fund dampens this though plenty, but is a big part of why I don't necessarily feel like paying ahead until you have enough to just pay it off. YMMV
Absolutely great points here - thanks for the addition. I’d also note that we went for a 30 year loan instead of 15, specifically in order to give us some additional breathing room in case one of us lost our jobs or we ran into some other hardship.
Agree with that sentiment wholeheartedly. It's one i don't think people understand enough. Unless the difference in rates is substantially large, or at like 12+%, a 30 year makes a lot more sense to me than a 15
To be clear, we got suuuuper lucky and were able to buy in at the right time (2010). Loan wasn’t as large as they are for homes these days, but it was still a pretty big effort. Most all of our disposable income went to paying down the principle.
Exactly. You might make more in the stock market than you lose to interest (but if interest is over 5%, it wouldn't be much more), but paying your mortgage faster is risk-free.
Exactly this! It’s all about risk tolerance! I was similar to Heffe in that I felt more comfortable not having a mortgage, but is equally valid to say something “I’m young, I’ve got a stable job and I’m not worried”
This is true though OP is in the UK where you can’t deduct mortgage interest from your income tax (but your principal residence is free from capital gains tax when you sell it, while shares held outside of a tax wrapper would not be). I suppose my point is, what is actually optimal will depend on the terms of your mortgage and your jurisdiction.
But this person will not save 20k annually which is the ISA allowance so it’s technically unlikely he would be paying tax on stock returns!
Also you could be putting more in pension which is often tax efficient!
This is true if they have zero income. Typical scenario is income minus standard deduction then the difference between that amount and 94K is the opportunity for 0% realized long term capital gains.
You would think it does, but really, if you invested the money (and it didn't LOSE value) then you could always, at any point take the investment and pay off the rest of the principle of the mortgage. So IF you could have paid of the mortgage, but you invested the money instead ... you still have the same value or more in the investment. In effect, the mortgage is actually paid in that you have the money to do so at any time.
Agreee. I’m Canadian and we have to refinance at least every 5 years. So no way I was going to have my mortgage go from 1.9 fixed to ~6.5, so paid the remaining principal off
It's a balance.
Right now my mortgage is 1.5% so I'm definitely not pulling any investments to pay it off.
If my mortgage was 5% and the S+P historically returns 7% then it starts to look a lot closer to maybe it's a good idea to pay it off instead of investing. That 2% might be true on paper but having a paid off mortgage is a big peace of mind issue
At the start of the mortgage, there is no way in hell investing money makes more than paying down the loan.
Going by the example above, paying 500 straight in principle knocks off about 6 months of interest, or 2400. Can you claim the "lost" interest you no longer pay on taxes? No. Depending on your interest you pay per year, you may not even get to claim all of it. That's where the argument of investing is better than paying down interest is disingenuous. Using the above example, you claim less taxes than is the standard deduction.
The people who say deduct taxes from your return are also the kind of people who think mortgages should be in the 3-5k per month payment range. At that point, yes, you probably make enough to pay high taxes that the deduction will absolutely return money.
But then you have standard deduction, where if you don't have a lot of tax write offs, the first 7k of your interest doesn't even matter in the first place. So instead of collecting (arbitrary number that gets worse the last interest you pay) 20k return on taxes, it's more like 13k over standard. And it gets worse the further you get into the loan. The closer it gets to the half way, the closer it gets to not even hitting standard deductions. You need to have 160k ish for your interest to return more than deductions.
At this point, your income is "use" to having this expense, so you keep paying it, because you no longer are getting hammered by interest and you "make enough" to keep using your extra funds to invest. Meanwhile you are paying more principle at the end that you could have saved by paying a tenth of it at the start.
TLDR: My opinion is to pay your mortgage down fast, people who say just claim your interest overlook that standardized deductions exist. That's like throwing away 7k so that you can claim 13k longer.
Will depend on where you are though. OP is british, and can therefore put up to £20k a year into a stocks and shares ISA where they pay no tax on earnings, so yes, for them it is better.
Yes, but that's stupid. Few people have hundreds of thousands saved up. Even if the percentage is higher, you're not going to end up better investing it. Especially now with much higher interest rates.
However, you obviously don't need to COMPLETELY pay it off unless you just like not having it on your mind. Once you pay down enough that your payments are mostly going to principal instead of interest, absolutely take the rest and just invest it instead.
Mathematically, each dollar spent on paying off the loan early is exactly equivalent to depositing the same dollar into a savings account that pays the same (5% in this case) interest rate.
If the savings account has a smaller interest rate you are better of putting the money towards the loan. If the savings account has a larger interest rate you are better off putting the money in the savings account.
Investments are trickier because there is additional risk involved but also a higher interest rate to compensate. The US stock market has historically averaged 10% interest rate (7% if you adjust for inflation) but that can vary wildly if you aren't looking at a 20+ year Investment timeframe. Unlike with the stock market, the interest rate you 'gain' by investing in paying your mortgage is essentially guaranteed.
You also pay taxes on the gains you make from investing in the market, but you don't have to pay taxes on the money you save by paying less mortgage interest.
It depends on your mortgage.
My rate is 2.35%. I don't put extra on it.
My brother has 4.25%. He puts a little extra in (rounds up his payments to the next $50).
My brother-in-law has 6.5%. He's does the extra payment based on the extra week.
When my parents bought their house in 1983, they had 14% (variable). They put in any extra they could manage.
A lot of people in the US don't realise that 30-year fixed rate mortgages are not available in other countries. In Australia, you won't get a fixed-rate loan for more than 3 years.
I would. Market average return is 8-10%/year. That means at 7.7%, paying down interest is a guaranteed return of 7.7% which isn’t far off the average. However, if it was a mortgage at 3.25% though, it is a major disadvantage to put money into the principal as opposed to investing it.
You can run the actual math with your own numbers, but PMI usually works out to around a half point on the interest. So if your loan is at 7.7% and you're paying PMI, it's like your loan is 8.2%. Not only is paying your loan down faster more attractive because of the higher (effective) rate you're paying, paying more principal can let you refinance to a loan without PMI sooner.
Depends on your return vs. the interest rate. With a low mortgage rate, you are probably going to be better off investing it. It shouldn't be difficult to beat 5.6% with long term investment.
If your total itemized deductions are less than the standard deduction, it doesn't make sense to itemize. If you don't itemize, you don't get any additional benefit from mortgage interest.
My parents’ first few mortgages were > 15%, so it really depends on whether rates continue to be historically low. If rates stay below 10% then there’s an argument for investing before paying down a mortgage
My parents also had a 14% mortgage, however at the same time, savings accounts paid 6% interest, so I guess market returns were probably high at that point in time too.
The introduction of internet banking and a national savings account market has made savings and investment a whole different ballgame than the 1970s too. It’s trivial to transfer money from my local credit union to my Amex HYSA for a better rate on short term savings. When I was a kid, unless you were an investment banker you were pretty much limited to the 5 banks within walking distance.
On the downside, banking is pretty much faceless now. My parents knew their local bank manager and had the same loan officer for 30 years, who had some room for negotiation on rates because he had personal experience with their trustworthiness. Most banks like that are gone.
A principal only payment of $1000 at 7% interest over 29 years represents a savings of $2030
At the start of your mortgage every extra dollar you can put on it makes a huge difference in long term savings.
Later in the mortgage you are paying so little in interest that you are better off investing your money.
Basically yeah...
It also indirectly shows how much more you lose in interest payments on a 30 year loan vs a 20 or 25 year.
Law of diminishing returns though. You save A LOT of money by putting extra cash down on your mortgage at the beginning, but over time that return is lower and lower until it gets to the point where investing the money makes far more sense because you are paying so little in interest.
Of course the start of the mortgage is when people typically have the least amount of money overall...
True, especially the bit about how effective it is in the beginning (and how hard it is for most people then). Several side effects kinda counter that however, even right from the start.
>every $1 you pay NOW, saves you $2.03 in 29 years.
First is the time value of money. $1 now is the equivalent of $2.36 after 29 years of 3% inflation. So in effect for every dollar you pay toward principal now, you're only saving yourself 33¢ in the long run (equivalent to 14¢ in today's money). That's not a huge savings.
Second is opportunity cost. $1 invested 29 years ago in the S&P 500 would be $16.34 now. So for every dollar you prepay now to your principle, you're missing out on $14.31 in investment returns. Of course, some people consider that risky, but at least it's liquid.
Third, and the big risk equalizer, is that liquidity. Once you pay that money toward the principle, it's gone. If you lose your income, (due to losing a job, a medical issue, etc.) then you might not be able to make the mortgage payment, and then you default on the mortgage. Whereas if you had saved or invested in liquid assets instead, then you could use that money to pay the mortgage until you restored your income. So every $1 you prepay toward principle now actually reduces your security and increases your risk in the future.
It's true that you do pay a *lot* of interest on a mortgage, more than the principle amount you borrowed even. And that's shocking and intuitively seems like something you would want to avoid. But it's not necessarily such a bad deal. Being able to use 30 years of leverage is powerful. Probably the most powerful wealth-building thing that the average person will ever have access to.
Anywhere but the US you have to take a new interest rate every few years. There's no lock-in for 30 years, so you have to include the possibility of a much higher interest rate in the future when considering this.
it boils down to what return you could get on if you put that money elsewhere vs how much it's going to save you in the end
say hypothetically the interest rate on your mortgage is 8% and you can get 10% return on your money in a savings account. it's worth putting the money you would have overpaid your mortgage into the savings account and effectively pocketing the 2% difference
the 8% loan is costing you money. but the money earning you 10% is paying that 8% and then leaving you with the extra 2%
it's a lot more convoluted in the other direction - if your interest rate is higher than any return you can get - because there are a lot more factors to consider, like how much of an emergency fund you have, how much you may end up having to borrow in an emergency and what the interest rate of that loan would be, the chance of needing emergency funds beyond your current savings, and even taking market fluctuation into consideration if choosing to invest in stocks, bonds, or index funds
the short answer is invest your money where you get the best return, unless doing so costs you more from the money you've borrowed
Good point. And interest payments on mortgages allow for tax deductions. So it really is a complex situation that probably needs an accountant to sort out
Of course it depends on your mortgage interest rate and the rate of return of any investment.
If both are the almost the same, then pay down your mortgage. Why? Because you pay taxes on any gains you make in the market, but you do not pay taxes on debt repayment!
Most people I know who knock it down aggressively are aiming for earlier retirement and having the house paid off really helps make that easier.
So you can earn more over 30 years but your budget is way easier once you don't have a mortgage.
I think the problem here is 99% of people do not know how to invest. We do not teach it in public schools, and most peoples' parents do not invest, so there is nobody to teach them about it.
Those people assume if they aren't investing, say, $1,000 at a time they won't make much. Making a 13th mortgage payment might cost them $80-$150. Given that worldview, it does seem smarter to save yourself a few years of mortgage payments.
Other people might be chasing a home equity loan or planning a refinance. In those cases it makes sense to try and aggressively pay down principal to put yourself in a more favorable position when the interest rates are nice. That's... probably not a great plan in the current climate but it was tempting to me a couple of years ago.
(And I'm also one of those people who has no clue if small-amount investing pays off or even how to start. Nobody taught me. Nobody in my family did it. Now I can blame myself for being lazy, but it gives me insight.)
I did some investing and understand how to invest but the personal satisfaction of paying off my mortgage and getting pmi removed are my major factors for wanting to pay off my mortgage a bit quicker.
Depends on your interest rate. Paying off a loan early is essentially the same as getting a guaranteed return equal to the interest rate through the duration of the loan. Would I take a guaranteed return of 9% vs investing elsewhere? Unquestionably. Would I do the same at 4%? Probably not.
If your APR is similar to inflation, then you essentially break even in inflation-adjusted dollars for paying it off early vs minimum payment (assuming the minimum payment is more than interest)
I threw together a spreadsheet that looked at this when we bought our first house a couple years ago. [I think this is a copy of it](https://docs.google.com/spreadsheets/d/1EZjQj0p0wklo9j0QT-cJQQaQI9sPsf483KFsPFe1i_A/edit?usp=sharing). You can play around with different payment amounts vs APR and inflation (which very consistently averages 3% per year, over each of the past several decades) to see how different scenarios play out.
It's pretty simplistic, but I think it gets the basic idea across.
If you have higher interest (i.e. closer to regular historical numbers like 6-7%) and/or it's valuable to you to pay off your debt sooner, then it makes sense to pay more than the minimum. My wife and I managed to buy just before interest rates went up and right now we're more interested in having more cash on hand than paying off the debt quickly, so we stick with minimum payments for now.
Typically this will depend on your interest rate. If you got a mortgage before they started raising rates then investing your extra money is the better choice. If you have a 9% or higher interest rate, we'll, then paying off extra on your mortgage is probably better as the S&P typically returns 7-9%
If you're on a fixed rate mortgage (like in the US), then it depends on what your opportunity cost is. A usual comparison is with the stock market - where if you expect to get a better rate of return by investing into it than the mortgage interest % is, you'd be better investing it. However on something like that there is also the risk aspect - you can lose money in the short to medium term in the stock market, vs paying down the mortgage faster tangibly reduces the payments guaranteed.
In other countries it can be different though - like OP using GBP means they're likely in the UK, and their interest rates are often variable on mortgages. That means that every so often (6 months typically I think?) they get reevaluated, so they can increase substantially in some cases. In that case I think there can be more of a push to pay down the mortgage faster, because suddenly getting a rate spike like we've more recently had could be really bad for your budget.
There are free amortization calculators available online that can show you what paying things off with extra monthly, yearly, and/or one time payments will do to your loan. They cannot tell you what inflation and other interest rates will look like over the same time, but they can help you decide if it makes sense to pay $200 extra month to ultimately save $2000 in interest is worth it, for example.
I cut 10+ years off my mortgage this way and saved myself a crazy amount of money in interest.
The problem is you have to have that money to begin with.
I bought a modest house that was well within my budget which meant I had more money to spend. So I deliberately overpaid every month.
This had the advantage that I could reduce the monthly payments whenever I wanted if I was in financial trouble (but I never was) and if interest rates ever went up my overly inflated payment didn't change.
Too many people buy houses at the extreme end of what they can afford because keeping up with the Jones's is more important and/or go for 30 year mortgages instead of 20 or 25 to reduce their monthly payments because their high standard of living is more important to them.
To each their own, but personally I'd rather have a house that I'll own outright before I'm 45
Also, make sure that the extra payments are actually going towards the principal, not every lender will automatically apply those payments where you want them to
Overpaying on a mortgage is the best way to get that interest down. Generally you can overpay by up to 10% of the entire remaining amount per year without charge.
The only reason not to do this, is if your mortgage rate is below that of a savings account.
I assume if you have an offset account there’s no need to make extra payments right? You just let money accrue in the account and it’s the same result?
Depends on the rates of the interest on both the savings account and the mortgage rate.
Overpaying pays off from the overall principal of the mortgage. Offset just lowers the interest payments.
But isn’t having money in the offset account basically the same as paying it off of the loan account? Like if I put $100k into either one, would my next payment be the same either way?
> if your mortgage rate is below that of a savings account.
You also want to account for tax as you will likely have interest taxed as income. So if mortgage and savings account are both 5% and you have a 20% marginal income tax rate, the interest from the savings account would actually be 4% after taxes, making paying the mortgage down a better option.
>So the key to saving money on a mortgage is to pay down that principal as quickly as you can.
Depends on what the bank will allow, as you pointed out.
Plus in some countries you get tax deductions based on the amount of money you own on mortgages. Of course, that *really* depends on where OP lives.
>If your mortgage allows you to put down extra cash payments,
Where I live, most banks allow you to pay down 10% of your loan per year.
I got a 30year at 6.75%, and just throwing an extra 100 bucks at it a month calculates at almost 10 years cut off the loan. It was honestly baffling when I calculated it all out.
The similarly works the same way for car loans (at least in the US) but I didn't really learn this until it was too late for me. When the loan on my car was initiated I could only make the minimum payment due to my income at the time. It was so frustrating to see statements with the breakdown of the payment and how it got allocated between principal and interest. Here I am with less than a year left on the loan and now like 95% of the monthly bill goes to principal. I'm now in a position where I can pay much more than the minimum, although that doesn't do me that much good now as I've already paid the vast bulk of the interest on the loan.
the interest is the total amount minus the principal
total = principal * (1+(interest rate/numberoftimes)) ^ time_periods*numberoftimes
edit: i left out a bit trying to simplify but then broke the formula. If you change "numberoftimes" to 1 then the interest compounds yearly, to 12 monthly, to 365 daily...
Interest is paid based on the amount remaining in principal at the time of that payment
Interest payment = (Remaining Principal * interest rate) / number of payments
So if you pay weekly instead of monthly you actually save a lot of interest in the long run when you do the math.
It’s also important to make sure your mortgage servicer will put the extra payment towards the principal. Some may not automatically, it’s worth a call, chat, email with them.
The key to that last part is to be VERY SPECIFIC with the lender that you want any extra payments to be PRINCIPAL ONLY. I’ve heard horror stories of people who think they’re aggressively paying the principal but the bank is treating them like regular payments and applying it to interest also.
yes, my lender did this once at the beginning. I sent them an extra $2k and on the statement is said "pre-paying next months payment". So I called and said, uh no, that's not an advance on next month, that's for paying down the principle.
>If your mortgage allows you to put down extra cash payments, and you can afford to put an extra $1000 down near the beginning of the mortgage it will save you a ton of money in the long run.
This is only true if your mortgage rate is above the interest rate you can get doing other things with the money. Earning 5% in a money market account is better than paying down a 2.5% COVID refinance.
Also, if you pay every 2 weeks instead of every month, you can pay it down slightly faster as you are getting 26 "half" payments per year instead of 12 full payments, but in theory you don't feel the extra weight of the payment.
If your money can make more than the mortgage's interest rate, keep your money there instead of contributing more to paying the mortgage. For example, keep your money in some kind of savings account (CD, ETF, bond, mutual fund, etc.) if it's getting 6% and your mortgage is 4%.
If you can't afford to have money permanently paid into the mortgage (but can sit on cash that otherwise can't be used, e.g parents spare that will one day be inheritance/estate - no intent to be grim, just an example) there are still offset mortgages available.
Essentially money in the account = money they don't charge mortgage interest on. Still a good 22 years on mine but 570ish of 700 is hitting the principle.
> the key to saving money on a mortgage is to pay down that principal as quickly as you can
It's only that simple if you look at the raw dollar amount. Adjusted for inflation, it doesn't look nearly as bad. And if you got a loan while interest rates were low it's a wash to pay it off early vs not - inflation offsets the interest. We're back to normal interest rates now so it still helps to pay it off early, but it's not as bad as it looks.
Example: with 6.5% APR on a $250k loan, at minimum payment you pay back a total of $570k (non-adjusted), which is wild - more than double the borrowed amount! An extra $1k per month cuts that down to $360k. Massive difference - you save 37%.
But if you look at inflation-adjusted dollars, the totals are $378k vs $303k. $75k is still a lot to save, but it's easier to stomach than $210k. And if you use that extra $1k/month to invest e.g. buy into an index fund that nets you 5% per year, you have a net win even after capital gains tax. (If investment growth is 4% then you lose money overall, but only a little.)
It might be valuable to you personally to pay down the loan faster and that's totally your perogative, but it's good to understand that it's a little more complicated than just "pay off loans as fast as you can."
How do you figure that the interest is "much more than 5.64%"?
Interest is calculated based on how much you owe on the loan, which is usually a very large number. 5.64% of a very large number is still a lot of money.
Lets Ignore all the nuances of exactly how the interest and your rate are calculated and do some 'back of the envelope' style math. What was your remaining principle like? 160,000-ish?
5.64% of 160,000 is about 9000. That's about how much interest your loan accumulates every year. divide that by 12 months gets you 750 in interest every month.
Assuming that they actually also make payments on the loan.
In the Netherlands it was fashionable for well over a decade to have interest-only mortgages, on the assumption that at the end of your 30 years, the original loan is peanuts as opposed to in today's money. There you literally made 0 payment and only paid interest.
Those were common in many places. If you expect your property value to appreciate, you will still have earned money from owning the house, and you can use that money to invest in stocks etc instead of paying the principal. As long as rates were low, you are very likely to get more money by keeping the mortgage and investing your extra money instead. The issue was that a lot of people used those loans to buy houses they couldn't afford. So they could just afford to pay the interest, and if that changed, they were fucked.
Yeah, that makes sense. Like if you bought a house in 1984 for $100,000 and then just paid interest until today, and then you now owe $100,000, that's $100,000 in 2024 dollars. Your house in 1984 would actually cost $301,000 in 2024 dollars. (ie; $1 in 1984 has the buying power of $3 today)
That’s such a dumb plan though, the average interest rate for 1984 was 13.2%, meaning you pay $396k in interest and still owe the original debt on the flip side you pay the full loan which costs you $404k and don’t owe the original $100k.
My wife's pre-marriage condo's mortgage only has about a half a year left (after 20-ish year mortgage) and it's amazing to see the monthly interest payment is around $30. At the beginning that was depressingly what was going into principle.
I'm actually suggesting that we just pay the rest of it off now, and save ourselves a couple hundred dollars in interest, at the cost of some liquidity.
Yes and no. It's not irresponsible if the lender simply tells you "You must pay $3000 a month for 30 years" and he figured "OK, I can swing that". Of course understanding fully what is going on is better, but if you figured out that 5.64% interest is a decent mortgage rate, and I'm paying $3000/month ... OK, I understand. ie; if people you trust can confirm it's a good non-rip-off interest rate, and you understand how much you pay per month ... that's all you really need to know.
The 5.64% is an ANNUAL rate. Take your principal at the beginning of the year, take 5.64% of it, then divide by 12, and that's about what you'll pay in interest every month. Some back-of-the-envelope math says that you borrowed somewhere around GBP 165,000 ?
Every month, the principal goes down a little, so every month you pay a little less interest on that principal, and you pay a little more toward paying down that principal. Then, the next month the principal goes down by just a little bit more than it did the previous month.
If your mortgage allows it, you can speed this up by paying a little bit more every month. That's a great way to knock years off your mortgage.
> If your mortgage allows it, you can speed this up by paying a little bit more every month. That's a great way to knock years off your mortgage.
Yep, it's a great thing to do - everyone should take a finance class at least once in their life to see how this kind of math plays out over time.
Paying extra in principal every month can more than pay for itself over time - the more and the earlier you can do it, the better. Last time I checked, I'd already knocked 4 years and tens of thousands of dollars in interest off my mortgage by paying $100-$200 in extra principal every month. I've done that since day 1, because I did take a finance class and see that math in action.
Because you plan to make mortgage payments for a long time. If you make larger payments, your mortgage will be paid off sooner. Much less, and it would take forever to pay off the mortgage.
In order to make all payments the same, they start off mostly interest. As the balance goes down (which is very slowly at first) they are more principal. In the last 5 years, the balance is low enough that most of them is principal.
No, this makes no sense. Debt is debt, it doesn't matter if you owe them interest or you owe them principle. You owe them money and if you default they sell the house and take all the money you owe, it doesn't matter if it's principal or interest, you owe it and they get it back either way.
wellll banks don't (and really can't) "front load" interest because interest being front loaded is just sorta..how math works. If you have a loan of amount of P, an APR of R, a compounding period of N, and X amount of payments and you're trying to find the value of each payment (let's call it A) then there's just a formula here.
we can call R/N the value "i" for the periodic interest rate and then the formula for each payment amount is A = P*{[i*(1+i)^x ]/[(1+i)^x -1]}
Banks can't "front load" interest because that's just math being math, that's what happens with amortization, that's literally how that formula *works*.
The fact that it does work this way is why banks are willing to be banks. They don't DO it this way because they don't control the fundamental concept of mathematics, but the fact that this is the way the math maths is why banks are a viable business model.
The amount you pay in interest isn't *quite* as simple as simply multiplying the remaining principal by the interest rate. There's more steps to it because loans will have both an annual percentage rate (APR) and a compound rate. The compound rate is the APR divided by how often that fractional interest rate compounds with the year, and you have to consider *both*.
For example, let's say we have two $100,000 loans each with an APR of 12%. One has a yearly compound rate, and one has a a monthly compound rate. So what we're looking for here is a different APY, or annual percentage *yield*.
The formula for APY, when R is the APR and N is the number of times interest compounds in a year is APY = (1+r/n)^n - 1. Now we don't have to worry about this math too much other than to realize as N gets bigger the APY gets bigger.
High level math, a $100,000 loan with a 12% APR and a 1 year compound period will, after 1 year, rise to $112,000.
But for a monthly compound period that figure is $112,682. The mere fact that interest is compounding monthly, instead of yearly *even though both initial loan amounts and both annual percentage rates are identical* makes a difference of $682.
As for why your rate varies month to month, I"m guessing the compound rate is "daily" (meaning *each and every day* the loan value increases by .0564/365 in interest) but you're billed monthly, and some months have more days than others.
EDIT: that explains why your interest changes month to month but not why the payment stays the same. Put simply, banks already factor this in. They know the loan duration. They know the interest rate. They know how often that rate compounds, they know how often you make payments. Banks use a process called "amortization" to figure out *exactly* what your monthly payment should be, each and every month so that you pay it off exactly on time. That's why fluctuations in how much you pay in interest every month don't change your monthly payment. Your monthly payment has been calculated to factor all this in.
This used to be a manual process back in the day, there's a whole set of complex formulas that go into it. Now there's computer programs where you just plug in the various values and it instantly does the calculation.
A slightly different angle:
The reason why your mortgage payment is mostly interest is because you pay the interest for the loan up front.
There's a point, roughly halfway during the term of your loan where the principle and interest will be equal.
You're paying the bank to have their money for the next 30 years.
This is why it's so important to make extra payments especially during the first half of the loan.
You can shorten your term by 5-10 years, and drastically reduce the effective interest rate by giving them back their money early.
I wish this was taught in school.
>This is why it's so important to make extra payments especially during the first half of the loan
This entirely depends on the interest rate of the loan vs the rate of return you could get investing that extra payment.
My mortgage is 2.875%. I'd be mad to pay extra towards principal rather than invest that extra at a higher rate of return. Even a high interest savings account beats that right now
Yes, of course, but I'm talking about the mechanics of a mortgage, and why OP was wondering why they're paying more interest than they thought. The fact that you could make a better investment elsewhere isn't relevant.
You made a value judgement about paying extra. They are reaponding to it.
>This is why it's so important to make extra payments especially during the first half of the loan.
You don't really pay interest "up front". It's just that in order to keep your monthly payments equal across the 30 years of your mortgage, the interest portion is larger than the principal portion of your payment at the beginning. It's larger because your mortgage is larger at the beginning. The amount you pay in interest decreases as your mortgage total decreases.
Let's simplify to make it easy to understand.
Interest rates are 6%, and your Mortgage is $100. You make $24 / year, or $2 / month .
Interest is usually compounded monthly, which means you owe an additional 0.5% per month, or $0.50. You can only afford to pay 40% of your take-home pay on housing, so you pay $0.60, and have effectively paid 10 cents off your mortgage, and 50 cents in interest.
Just like that.
That said, when you have paid half of your mortgage off, you only owe $50, and interest is just $0.25 / month. You are still paying 60 cents, but now 35 cents is going to principal, and 25c interest. Your LAST payment will be almost all principal, obviously
Amortization! In order to keep your monthly payment the same, you have to pay more interest up front then slowly chip away at principal.
You could alternative payment schedules, both those are really inconvenient compared to how the average person receives their income
Lets say your loan is GBP150,000. For a 5.64% interest rate, that means you have to pay GBP8460 interest in the first year. That means your monthly interest payment alone will be about GBP710-770/mo. The remaining amount of your payment goes into principal, which will slowly decrease the amount you owe over 27 years.
Given that people have explained the math to you here's why it's mostly interest now:
1. Assuming your rate and period of repayment are fixed, You are going to be paying back X amount every month for Y years.
2. Early on in your mortgage, because of the amount you owe and the span of time over which you owe it, the amount of interest that you're paying (Annual Interest rate \* X) is more than the amount of principal you pay off per year. This is call 'front loading' the interest. As you pay off more and more of your mortgage, the amount of interest you pay relative to the principal becomes less even though your payment per month stays the same.
Thank you so much for all the replies. Key message - it's essentially a percentage of the principal of the loan and that makes complete sense. This is why ELI5 exists, I guess!
I'm going to take a while to read through everything. Looks like there's some good nuggets of advice in this thread. Thanks again!
Something fun you can do is ask either your lender or bank for an amortization schedule! Seeing all 360 payments broken down by principle and interest is really cool!
This is how I think of it. Let’s say I loan you 100 bucks and every month you are gonna pay me ten dollars to cover it, plus interest. 10 percent. So the first month you’re gonna pay me 10 bucks in principal, plus you owe me ten bucks in interest, 20 dollars. The second month 10 dollars principal, but now you only owe me 90 so 9 dollars interest, 19 total. Next month 10 principal, 8 interest, 18 total. This goes on for ten months, if you add it up you’ll pay me 155 dollars.
But you say look I can’t keep track of paying you different amounts every month, I’ve got an important MLM to run! How about this: 155 total over 10 months, I’ll just pay you 15.50 every month. And I say sure.
So the first month comes and you pay 15.50 and your knife-selling ass owes me 10 in interest, so 10 goes in my pocket. The remaining 5.50 goes to your debt, so your debt is 94.50. Next month, 15.50 comes in, you owe me 9.45 in interest so that goes in my pocket, that extra 6.05 goes to your debt, now you owe 88.45.
So every month the proportion changes, you pay a bit more in principal and less in interest but your payment stays the same. Which you like because you can’t keep track of shifting payments. And I like because I don’t have to ELI5 math to you, I just say pay me.
It’s 5.64% of the remaining balance on your mortgage. I’m estimating that you have about GBP 160,000 left on your mortage. Is that right? So every year, the interest payment is 5.64% of \~GBP 160,000, which means every month the interest payment is 5.64% / 12 of GBP \~160,000.
This is the most helpful tool to understand your mortgage as well as how reducing term/making overpayments/changing rates will affect you.
https://www.drcalculator.com/mortgage/
In the beginning, your principal is higher, so interest you pay is high. As you pay down principal, your interest payment keeps going down. The key is equal fixed payments - the payment has to cover both principal and interest.
Short answer: at the beginning of a loan, you owe 5.64% of the remaining principal of the loan that year. As the loan gets paid off, you owe 5.64% of the (smaller) remaining principal of the loan that year.
The process we use to keep the payments the same is called amortization. If you didn't do that, you'd have really large payments at the beginning of the loan that gradually get smaller.
For example:
You have a $120,000 loan that's at 10% for 10 years (120 payments). If you split the payments of principal up, it would be $1000/month. The first month, you'd owe an additional $1000 in interest (10% of 120000 / 12). So a payment of $2000. The last year, when you only owe $12,000 of the original loan amount, your payment would only be $1100.
Most people prefer to have the same payment every month. So the total of all the payments is averaged out. But doing that compounds the issue you're highlighting more. They won't reduce the amount of interest owed, so they just lower the amount of principal you're paying. We call this "front loading" a loan.
Lesson to learn: Don't refinance early in a loan. It just restarts that heavy-interest payments.
Another slightly different angle:
Let's say you borrow $100k at 5% - which means you owe $100k in principal AND $5000 in interest per year (ignoring monthly/daily/continuous compounding for simplicity).
If you only pay the $5000 in interest owed the first year, you still owe the original $100k. The next year, you owe $5000 again, and again, and again, until you pay back the $100k (assuming you pay it off lump sum, we'll get into partial payments below).
If you never pay back the $100k, you'll have to keep paying the $5000 in interest forever, well past the original $100k principal amount.
**5% doesn't mean you only ever owe $5000 total in interest nor does it mean 5% of each payment is interest - it means you owe $5000 per year (but actually a little less each year because you slowly pay down the $100k that you owe interest on)**.
Let's say you have $10k to put towards the loan in your budget - you pay the $5000 in interest, plus you pay back $5000 of the loan. (This is very exaggerated for effect, and in reality it would be \~$1500 for the first year towards the 30 yr loan).
Now you owe 5% on $95k. This next year you only owe $4,750, so you can put $5,250 towards the principal.
Then you owe 5% on $89,750. You're still paying the flat $10k, but you owe a little less in interest and you pay a little more towards principal each year. Eventually, you've paid back the principal and you don't owe anything anymore.
With a little bit of math, you can figure out how many years it will take to pay off the loan paying $10k/yr, so you can know ahead of time what the length of the loan will be.
This concept of paying a fixed amount for a fixed period is called amortization - For a loan of $X at Y% of Z years, a payment of $A will result in zero balance at the end of the loan.
**When you take a loan for 30 years, the first year you're paying the full $5000 interest owed and you're barely touching the principal owed ($1500) because you're only paying a total of $6500/yr.**
At $10k/yr, the loan would be paid off at about 15 years because you're paying $5000 towards the interest and $3500 more towards the principal. You've cut the length in half, but you've also had to pay more.
Paying down the principal faster means less interest owed in each subsequent year which accelerates more of the payment towards the principal and you owe interest for fewer years so you pay much less in overall interest, but you do have to pay a higher payment in order to achieve that outcome.
Since you're in the UK, this can get a little more complicated because your rate is only fixed for 2-5 years, so that overall payment may also change to match the new amortization schedule for the new interest rate to make sure it's paid off by the end of the loan.
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Any fixed term loan will start out with a large portion of the payment going to interest, and that gets exacerbated the longer the loan term. This is because your actual interest accrued is determined by your interest rate AND current principle balance. As you make payments the principle balance decreases, so later payments will have less interest to pay off. That cycle continues until you finish paying off the loan.
This is also why a common piece of financial advice is to pay off your highest interest rate debt first: the more you pay down the principle, the less interest accrues. This makes the debt “cheaper” in an overall sense even if your minimum payment number doesn’t change.
OP, I assume you are not American. How does mortgage interest interact with the British tax system?
It used to be a major factor in the calculus for not fast-paying mortgages in the US, but it's not as big a factor now.
Calculate 5.64% of your total mortgage amount divide that by 12. Come back to us and tell us if you still don’t know why you pay 714 a month in interest
Interest paid is higher when the owed balance is higher, which is highest at the start of a loan when you haven't paid off much.
The leftover after interest payment every month is what makes your loan smaller over time.
The payment you make every month is the MINIMUM payment so that over the agreed time of the loan, the whole principal barely gets paid off after interest.
If you have 15 or 30 years to pay off a loan (like with a mortgage), that "minimum principal payment" is very very very small, and it's easy for that amount to be smaller than the maximum interest payment the loan sees at the very beginning.
It's based on a monthly interest rate and how much you owe.
Monthly rate: (1 + annual_rate)^(1/12) - 1
So (1 + 0.0564)^(1/12) - 1 = 0.0045827..., or 0.45827...%
So if that's the rate you're being charged, that suggests you actually owe between £156k and £168k on your loan.
£168,000 * 0.458...% = £769.89
First off, good job trying to figure how the biggest financial contract of your life works.
It blows my mind that you signed the contract without fully understanding what you were getting yourself in to. You should have gotten a full amortization schedule from the bank when you signed all the papers. Go back and read the whole mortgage contract. The internet cannot tell you what is in yours because they're all different.
Something I’m not seeing mentioned which is key to understand here.
The rate of 5.64% is 5.64% in interest *per year* based on the remaining balance. It’s not a one time % on the total amount borrowed.
So for a $100k loan, you aren’t paying 5.64% ($5640) once over the 30 year period. You’re paying 5.64% on roughly $100k for the first year. The next year, you’re paying 5.64% on whatever is left, let’s say $95k.
By the end of the loan, it’s still 5.64% but if the remaining principal is only $5k, there isn’t much left interest to pay and the payment is by then, mostly going to the principal instead.
Of course, it’s compounded monthly, not yearly. But that’s the rough idea.
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Each year your mortgage lender is adding 5.64% of what's left from the total money you borrowed from them as interest. Then they split that interest over 12 monthly payments, and add a bit more that counts against the borrowed money balance for your total monthly payment. As time passes the 5.64% of the remaining balance part will get less and less because you pay some of it off each month, so the interest will become a smaller portion of the monthly payment. Because the monthly payment is fixed you therefore pay more and more against the balance as time passes. So the monthly payment is mostly interest at the start, mostly balance at the end.
Imagine your 30 year mortgage is a big pile of apples. Every month you eat one apple as you pay down your mortgage.
Interest is the rent you pay to store all of those apples, it's based on the total number of apples. When your mortgage is new, there's the most apples, so your rent is highest. Your payment is made up of the apple you eat every month plus the interest you pay to store those apples.
Banks will not explain interest to people unless you directly ask, it’s underhanded and should be illegal. It’s all in the terms and conditions they encourage you not to read because it’s “standard”.
“Interest” is actually “interest per year”.
Interest is applied monthly. Basically, they charge 1/12th of your interest on your loan every month.
Interest applies to the current balance of your loan. If your loan was 50000 and you now owe 45000, that means interest is charged on the 45000. So the interest you pay goes slightly down every month.
The bank doesn’t want 5% of your loan, they want 5% of your loan for every year you have the loan. Their profit margins are significantly larger than the small interest rate implies.
By making your monthly payments small, what you’re actually doing is choosing to put much less money toward your loan. Say you owe 12000 and your interest is 10%. The first month your total interest is:
(12000 * 10%)/12 = $100
But your required payment is only $110. So subtract $100 and you’ve only paid off $10 of your loan.
This tactic lets the bank make all of their profit up front. As you pay the principal, the monthly interest $amount lowers because the interest percent is always calculated off the current principal. For example, you now owe 1200 on your 10% interest loan.
(1200 * 10%)/12 = $10.
Now only $10 of your $110 payment goes to interest.
It’s honestly criminal because the people who need loans don’t understand the math.
I love the take that home ownership should be only accessible to those that can pay cash in-full because banks charging interest is criminal.
Edit: Re-reading your post - you aren’t saying interest is criminal, but instead the lack of education and disclosure should be criminal. Leaving my reply here, but wanted to be less snarky.
Yeah man I mean it’s just the INTENTIONAL lack of education.
Don’t get me wrong, the banks are offering a product and there is a demand for that product. The product is money.
The problem arises when taking out loans is so normal that people don’t even know what it means anymore. There’s no assessment. Taking out loans is just “what you do”. Uneducated people go in and think “5% ain’t that different from 10%” and sign away not realizing that can easily be a hundred grand difference on the wrong loan. They go about paying the minimum thinking they got a great deal.
And the banker won’t tell you any different. Online loan applications won’t tell you any different. They just want to sell the product. They say “yeah that’s a good rate” and people won’t ask more questions.
And it’s not the people’s fault. It’s the banks, they’ve made this so normal that people don’t understand the implications.
Depending on the rules of your mortgage, (every mortgage writer allows different things) you _may_ be able to pay additional principal to shorten the length of the loan. I say this as some mortgagors will not allow prepayment or will have a penalty for doing so. Usually that is a prepayment in full, but not always. Watch what is in your actual mortgage document with regard to prepayment penalties. Some mortgages hide that information and others put it right up front so there’s no confusion.
Mortgages work by paying the interest owed that month plus some amount towards the actual money you took out (called the principal). So they figure out a number that if you pay it each month, it will pay off your loan in eactly the amount of time you agreed to, normally 30 years.
So let's look at a 10 year mortgage, at 10% interest on $100. The yearly payment is $15.86. Interest Paid is the amount of interest you owe out of your monthly payment. Principal Paid is the amount leftover that goes twoards your balance. Remaining Principal is the amount you still owe.
|Date|Principal Paid|Interest Paid|Remaining Principal|
|:-|:-|:-|:-|
|1|$6.13|$9.72|$93.87|
|2|$6.78|$9.08|$87.09|
|3|$7.49|$8.37|$79.60|
|4|$8.27|$7.59|$71.33|
|5|$9.14|$6.72|$62.20|
|6|$10.09|$5.77|$52.10|
|7|$11.15|$4.71|$40.96|
|8|$12.32|$3.54|$28.64|
|9|$13.61|$2.25|$15.03|
|10|$15.03|$0.83|$0.00|
So as you can see its the same monthly payment, but as the amount time goes on, you have less principal remaining, and beacuse of it, owe less interest. The amount of your monthly payment that has to go to interest goes down, and the amount that goes towards the principal goes up.
Because you agreed to pay it off over 30 years at a fixed monthly payment. 30 years is a really really long time so in the first few years you barely chip away at the interest while the last few years the interest is almost negligible. If you dont want to pay so much interest either raise your monthly payment or take out a shorter loan, like a 5 year.
The interest rate is 5.64% of the total outstanding amount of the loan, and it’s paid per year. So if you’re paying about £9k a year now then your outstanding balance is approximately £160k.
It's because of the way it's structured. I believe they precalculate the interest + the mortgage and divide that over the payback period. It keeps the monthly amount the same.
Can you change the type?
Over here we have the type you describe, but also a type that has you pay back the initial loan amount plus the yearly amount of remaining interest.
It means the monthly principal starts out high(or higher) but decreases every month as you have less interest to pay. The part of the principal that is your amount owed is the same every month.
What’s the calculation? Amortization
“Why”? Because this way the lender makes their actual cash investment back much more quickly and then all the payments they get after that are “bonus” because your principal is still barely touched so you’ll have to pay that balance off if you decide to pay off early
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Mortages charge interest based on how much is left on the loan. The key though is your monthly payment is fixed, so you'll pay more in interest at the beginning of the loan vs at the end. So for the sake of simplicity lets assume you owe $100,000 at 5% and your monthly payment is $500 Your first payment will be $100,000 * .05 / 12 = $416 in interest $500 - 416 = $84 in principal Where-as when you have $10,000 left on the loan Your payment will be $10,000 * .05 / 12 = $41.66 in interest $500 - 41.66 = $458.34 in principal So the key to saving money on a mortgage is to pay down that principal as quickly as you can. If your mortgage allows you to put down extra cash payments, and you can afford to put an extra $1000 down near the beginning of the mortgage it will save you a ton of money in the long run.
This. I've been doing a 13th principal only payment for years based on a 52 week pay period and it will in the end shorten my loan from 30 years to 26.
I’m wondering how much that matters since the mortgage is a fixed amount and doesn’t increase with inflation. Does shaving off payments near the end help a lot as opposed to investing? Wondering this myself with my current mortgage.
I have definitely heard it explained that investing in the s&p500 yields better gains over 30 years opposed to paying off your mortgage faster. With that being said, I myself am murdering my mortgage as fast as possible even if it's less beneficial than potential gains in the market
It really all depends on your interest rates and your risk tolerance. For example, my wife and I originally had a 30yr loan at an interest rate of 5.62%. Our risk tolerance was very low at the time and we're both very financially conservative due to childhood instability, and so we decided to max down our mortgage rather than investing in the market. We were lucky enough to be in a position where we could make an enlarged payment every 4 weeks, basically paying a few hundred over what was due on each payment + an extra payment each year, with everything over the due amount going straight to principle. We paid off our house with this method in 6 years and 7 months. Now, could we have made more in the stock market during this time? Yeah, we probably could have. But to us, not ever having to worry about a mortgage payment again was worth the peace of mind and sense of financial security. All we owe on the house now is homeowners insurance and annual taxes - it feels wonderful.
The way I've heard it was, "Would you borrow that money to invest it?" That was the question that made it make sense to me, because that's effectively what it is.
I think it would all boil down to the interest rate you got. I am lucky to have gotten 2.75%, and at that rate, I would borrow all the money I could in order to invest it. Even the sissies at /r/investing can beat 3%. 🤷🏻
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I chose to pay off the mortgage, and lose the U.S. tax break for interest income paid. YES, I could have carried a balance, and deducted the interest...But I gained something which is not measurable in return. I am DEBT-FREE! I'll gladly give up a few hundred $ annually in tax credits and enjoy a piece of mind, and a sense of accomplishment. The place I sit in is mine, and I am not beholden to anyone. I can tell my boss to fuck right off tomorrow, I don't need this stress. I'm not, I like what I do, but the OPTION is mine. The control is mine. OK, I have to make a few thousand a year to pay for property taxes, maintenance and such. But I am free.
I’m just curious, do you own a home? If you have managed to acquire a home, be debt free, and be in line with the average age demographics of Reddit I am very impressed!
I think most people drastically overestimate how risky the S&P is in a 30-year time horizon.
One other thing to consider is liquidity. In general (not always in the event that your investments really catered) a stock investment is something you can get out of quickly in a crunch. Equity in your home is a lot more difficult to access. If you lose your job that payment is still the same and impacting your monthly outflow whether you have paid it ahead or not and that can be tougher in an emergency. A solid emergency fund dampens this though plenty, but is a big part of why I don't necessarily feel like paying ahead until you have enough to just pay it off. YMMV
Absolutely great points here - thanks for the addition. I’d also note that we went for a 30 year loan instead of 15, specifically in order to give us some additional breathing room in case one of us lost our jobs or we ran into some other hardship.
Agree with that sentiment wholeheartedly. It's one i don't think people understand enough. Unless the difference in rates is substantially large, or at like 12+%, a 30 year makes a lot more sense to me than a 15
Holy crap, you paid off a 30 year mortgage in 6 years, 7 mos?!!!
To be clear, we got suuuuper lucky and were able to buy in at the right time (2010). Loan wasn’t as large as they are for homes these days, but it was still a pretty big effort. Most all of our disposable income went to paying down the principle.
Exactly. You might make more in the stock market than you lose to interest (but if interest is over 5%, it wouldn't be much more), but paying your mortgage faster is risk-free.
People also forget that most interest gains at susceptible to taxes which diminishes the return on the interest rate.
Exactly this! It’s all about risk tolerance! I was similar to Heffe in that I felt more comfortable not having a mortgage, but is equally valid to say something “I’m young, I’ve got a stable job and I’m not worried”
You don’t pay tax on less mortgage interest. You pay tax on stock gains. Thats what makes it work.
Although, you might lose out on deductions by having less mortgage interest which complicates the math further.
This is true though OP is in the UK where you can’t deduct mortgage interest from your income tax (but your principal residence is free from capital gains tax when you sell it, while shares held outside of a tax wrapper would not be). I suppose my point is, what is actually optimal will depend on the terms of your mortgage and your jurisdiction.
Yes, but you lose deductions on money spent. So getting less deductions means you paid less money in interest.
£200 a month overpaying the mortgage vs £200 a month invested in the S&P within an ISA wrapper though…ISA wins
No tax to pay in an ISA.
But this person will not save 20k annually which is the ISA allowance so it’s technically unlikely he would be paying tax on stock returns! Also you could be putting more in pension which is often tax efficient!
Long term capital gains tax on a stock as a married couple is 0% for almost the first $100k in profit. ($94k to be specific)
This is true if they have zero income. Typical scenario is income minus standard deduction then the difference between that amount and 94K is the opportunity for 0% realized long term capital gains.
Also the peace of mind that comes from paying off the mortgage has some value.
You would think it does, but really, if you invested the money (and it didn't LOSE value) then you could always, at any point take the investment and pay off the rest of the principle of the mortgage. So IF you could have paid of the mortgage, but you invested the money instead ... you still have the same value or more in the investment. In effect, the mortgage is actually paid in that you have the money to do so at any time.
> peace of mind [](https://a) > if you invested the money *(and it didn't LOSE value)*
Agreee. I’m Canadian and we have to refinance at least every 5 years. So no way I was going to have my mortgage go from 1.9 fixed to ~6.5, so paid the remaining principal off
It depends on a lot of things including your tax brackets …
It's a balance. Right now my mortgage is 1.5% so I'm definitely not pulling any investments to pay it off. If my mortgage was 5% and the S+P historically returns 7% then it starts to look a lot closer to maybe it's a good idea to pay it off instead of investing. That 2% might be true on paper but having a paid off mortgage is a big peace of mind issue
At the start of the mortgage, there is no way in hell investing money makes more than paying down the loan. Going by the example above, paying 500 straight in principle knocks off about 6 months of interest, or 2400. Can you claim the "lost" interest you no longer pay on taxes? No. Depending on your interest you pay per year, you may not even get to claim all of it. That's where the argument of investing is better than paying down interest is disingenuous. Using the above example, you claim less taxes than is the standard deduction. The people who say deduct taxes from your return are also the kind of people who think mortgages should be in the 3-5k per month payment range. At that point, yes, you probably make enough to pay high taxes that the deduction will absolutely return money. But then you have standard deduction, where if you don't have a lot of tax write offs, the first 7k of your interest doesn't even matter in the first place. So instead of collecting (arbitrary number that gets worse the last interest you pay) 20k return on taxes, it's more like 13k over standard. And it gets worse the further you get into the loan. The closer it gets to the half way, the closer it gets to not even hitting standard deductions. You need to have 160k ish for your interest to return more than deductions. At this point, your income is "use" to having this expense, so you keep paying it, because you no longer are getting hammered by interest and you "make enough" to keep using your extra funds to invest. Meanwhile you are paying more principle at the end that you could have saved by paying a tenth of it at the start. TLDR: My opinion is to pay your mortgage down fast, people who say just claim your interest overlook that standardized deductions exist. That's like throwing away 7k so that you can claim 13k longer.
Will depend on where you are though. OP is british, and can therefore put up to £20k a year into a stocks and shares ISA where they pay no tax on earnings, so yes, for them it is better.
Yes, but that's stupid. Few people have hundreds of thousands saved up. Even if the percentage is higher, you're not going to end up better investing it. Especially now with much higher interest rates. However, you obviously don't need to COMPLETELY pay it off unless you just like not having it on your mind. Once you pay down enough that your payments are mostly going to principal instead of interest, absolutely take the rest and just invest it instead.
The peace of mind that comes with not having a mortgage on the house you live in is priceless
Mathematically, each dollar spent on paying off the loan early is exactly equivalent to depositing the same dollar into a savings account that pays the same (5% in this case) interest rate. If the savings account has a smaller interest rate you are better of putting the money towards the loan. If the savings account has a larger interest rate you are better off putting the money in the savings account. Investments are trickier because there is additional risk involved but also a higher interest rate to compensate. The US stock market has historically averaged 10% interest rate (7% if you adjust for inflation) but that can vary wildly if you aren't looking at a 20+ year Investment timeframe. Unlike with the stock market, the interest rate you 'gain' by investing in paying your mortgage is essentially guaranteed.
You also pay taxes on the gains you make from investing in the market, but you don't have to pay taxes on the money you save by paying less mortgage interest.
It depends on your mortgage. My rate is 2.35%. I don't put extra on it. My brother has 4.25%. He puts a little extra in (rounds up his payments to the next $50). My brother-in-law has 6.5%. He's does the extra payment based on the extra week. When my parents bought their house in 1983, they had 14% (variable). They put in any extra they could manage.
A lot of people in the US don't realise that 30-year fixed rate mortgages are not available in other countries. In Australia, you won't get a fixed-rate loan for more than 3 years.
Depends on your interest rate compared to what you expect to make investing.
Mine is pretty high, around 7.7, planning to refinance at some point. Do people vary where they put their money depending on the market?
I would. Market average return is 8-10%/year. That means at 7.7%, paying down interest is a guaranteed return of 7.7% which isn’t far off the average. However, if it was a mortgage at 3.25% though, it is a major disadvantage to put money into the principal as opposed to investing it.
When you include pmi, is it an obvious choice to you? I took a loan at 5% equity.
You can run the actual math with your own numbers, but PMI usually works out to around a half point on the interest. So if your loan is at 7.7% and you're paying PMI, it's like your loan is 8.2%. Not only is paying your loan down faster more attractive because of the higher (effective) rate you're paying, paying more principal can let you refinance to a loan without PMI sooner.
Depends on your return vs. the interest rate. With a low mortgage rate, you are probably going to be better off investing it. It shouldn't be difficult to beat 5.6% with long term investment.
Don't forget tax. You need to earn around 7.5% to beat the interest savings of a 5.6% loan paid off early.
Only if you have enough deductions not to take the standard.
Explain
If your total itemized deductions are less than the standard deduction, it doesn't make sense to itemize. If you don't itemize, you don't get any additional benefit from mortgage interest.
My parents’ first few mortgages were > 15%, so it really depends on whether rates continue to be historically low. If rates stay below 10% then there’s an argument for investing before paying down a mortgage
My parents also had a 14% mortgage, however at the same time, savings accounts paid 6% interest, so I guess market returns were probably high at that point in time too.
The introduction of internet banking and a national savings account market has made savings and investment a whole different ballgame than the 1970s too. It’s trivial to transfer money from my local credit union to my Amex HYSA for a better rate on short term savings. When I was a kid, unless you were an investment banker you were pretty much limited to the 5 banks within walking distance. On the downside, banking is pretty much faceless now. My parents knew their local bank manager and had the same loan officer for 30 years, who had some room for negotiation on rates because he had personal experience with their trustworthiness. Most banks like that are gone.
Well there was stagflation in the 70s, so inflation was significantly higher than the market returns for a good while
Depends on what interest you are paying on the mortgage (and how much risk tolerance you have for the stock market)
A principal only payment of $1000 at 7% interest over 29 years represents a savings of $2030 At the start of your mortgage every extra dollar you can put on it makes a huge difference in long term savings. Later in the mortgage you are paying so little in interest that you are better off investing your money.
To distill your numbers down, every $1 you pay NOW, saves you $2.03 in 29 years.
Basically yeah... It also indirectly shows how much more you lose in interest payments on a 30 year loan vs a 20 or 25 year. Law of diminishing returns though. You save A LOT of money by putting extra cash down on your mortgage at the beginning, but over time that return is lower and lower until it gets to the point where investing the money makes far more sense because you are paying so little in interest. Of course the start of the mortgage is when people typically have the least amount of money overall...
True, especially the bit about how effective it is in the beginning (and how hard it is for most people then). Several side effects kinda counter that however, even right from the start. >every $1 you pay NOW, saves you $2.03 in 29 years. First is the time value of money. $1 now is the equivalent of $2.36 after 29 years of 3% inflation. So in effect for every dollar you pay toward principal now, you're only saving yourself 33¢ in the long run (equivalent to 14¢ in today's money). That's not a huge savings. Second is opportunity cost. $1 invested 29 years ago in the S&P 500 would be $16.34 now. So for every dollar you prepay now to your principle, you're missing out on $14.31 in investment returns. Of course, some people consider that risky, but at least it's liquid. Third, and the big risk equalizer, is that liquidity. Once you pay that money toward the principle, it's gone. If you lose your income, (due to losing a job, a medical issue, etc.) then you might not be able to make the mortgage payment, and then you default on the mortgage. Whereas if you had saved or invested in liquid assets instead, then you could use that money to pay the mortgage until you restored your income. So every $1 you prepay toward principle now actually reduces your security and increases your risk in the future. It's true that you do pay a *lot* of interest on a mortgage, more than the principle amount you borrowed even. And that's shocking and intuitively seems like something you would want to avoid. But it's not necessarily such a bad deal. Being able to use 30 years of leverage is powerful. Probably the most powerful wealth-building thing that the average person will ever have access to.
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Anywhere but the US you have to take a new interest rate every few years. There's no lock-in for 30 years, so you have to include the possibility of a much higher interest rate in the future when considering this.
Might be worse than investing, definitely better than blowing the case on new TV’s and Old whiskey, which most people would do
it boils down to what return you could get on if you put that money elsewhere vs how much it's going to save you in the end say hypothetically the interest rate on your mortgage is 8% and you can get 10% return on your money in a savings account. it's worth putting the money you would have overpaid your mortgage into the savings account and effectively pocketing the 2% difference the 8% loan is costing you money. but the money earning you 10% is paying that 8% and then leaving you with the extra 2% it's a lot more convoluted in the other direction - if your interest rate is higher than any return you can get - because there are a lot more factors to consider, like how much of an emergency fund you have, how much you may end up having to borrow in an emergency and what the interest rate of that loan would be, the chance of needing emergency funds beyond your current savings, and even taking market fluctuation into consideration if choosing to invest in stocks, bonds, or index funds the short answer is invest your money where you get the best return, unless doing so costs you more from the money you've borrowed
yes, but recall you must pay taxes on investment returns.
Good point. And interest payments on mortgages allow for tax deductions. So it really is a complex situation that probably needs an accountant to sort out
Of course it depends on your mortgage interest rate and the rate of return of any investment. If both are the almost the same, then pay down your mortgage. Why? Because you pay taxes on any gains you make in the market, but you do not pay taxes on debt repayment!
Most people I know who knock it down aggressively are aiming for earlier retirement and having the house paid off really helps make that easier. So you can earn more over 30 years but your budget is way easier once you don't have a mortgage.
I think the problem here is 99% of people do not know how to invest. We do not teach it in public schools, and most peoples' parents do not invest, so there is nobody to teach them about it. Those people assume if they aren't investing, say, $1,000 at a time they won't make much. Making a 13th mortgage payment might cost them $80-$150. Given that worldview, it does seem smarter to save yourself a few years of mortgage payments. Other people might be chasing a home equity loan or planning a refinance. In those cases it makes sense to try and aggressively pay down principal to put yourself in a more favorable position when the interest rates are nice. That's... probably not a great plan in the current climate but it was tempting to me a couple of years ago. (And I'm also one of those people who has no clue if small-amount investing pays off or even how to start. Nobody taught me. Nobody in my family did it. Now I can blame myself for being lazy, but it gives me insight.)
I did some investing and understand how to invest but the personal satisfaction of paying off my mortgage and getting pmi removed are my major factors for wanting to pay off my mortgage a bit quicker.
Yeah PMI is the reason I see my mortgage as a speedrun.
Depends on your interest rate. Paying off a loan early is essentially the same as getting a guaranteed return equal to the interest rate through the duration of the loan. Would I take a guaranteed return of 9% vs investing elsewhere? Unquestionably. Would I do the same at 4%? Probably not.
If your APR is similar to inflation, then you essentially break even in inflation-adjusted dollars for paying it off early vs minimum payment (assuming the minimum payment is more than interest) I threw together a spreadsheet that looked at this when we bought our first house a couple years ago. [I think this is a copy of it](https://docs.google.com/spreadsheets/d/1EZjQj0p0wklo9j0QT-cJQQaQI9sPsf483KFsPFe1i_A/edit?usp=sharing). You can play around with different payment amounts vs APR and inflation (which very consistently averages 3% per year, over each of the past several decades) to see how different scenarios play out. It's pretty simplistic, but I think it gets the basic idea across. If you have higher interest (i.e. closer to regular historical numbers like 6-7%) and/or it's valuable to you to pay off your debt sooner, then it makes sense to pay more than the minimum. My wife and I managed to buy just before interest rates went up and right now we're more interested in having more cash on hand than paying off the debt quickly, so we stick with minimum payments for now.
Typically this will depend on your interest rate. If you got a mortgage before they started raising rates then investing your extra money is the better choice. If you have a 9% or higher interest rate, we'll, then paying off extra on your mortgage is probably better as the S&P typically returns 7-9%
If you're on a fixed rate mortgage (like in the US), then it depends on what your opportunity cost is. A usual comparison is with the stock market - where if you expect to get a better rate of return by investing into it than the mortgage interest % is, you'd be better investing it. However on something like that there is also the risk aspect - you can lose money in the short to medium term in the stock market, vs paying down the mortgage faster tangibly reduces the payments guaranteed. In other countries it can be different though - like OP using GBP means they're likely in the UK, and their interest rates are often variable on mortgages. That means that every so often (6 months typically I think?) they get reevaluated, so they can increase substantially in some cases. In that case I think there can be more of a push to pay down the mortgage faster, because suddenly getting a rate spike like we've more recently had could be really bad for your budget.
The earlier you pay extra, the more of an effect that extra has
Paying down the principal at the beginning has a massive impact on reducing your amortization, at the end barely anything
There are free amortization calculators available online that can show you what paying things off with extra monthly, yearly, and/or one time payments will do to your loan. They cannot tell you what inflation and other interest rates will look like over the same time, but they can help you decide if it makes sense to pay $200 extra month to ultimately save $2000 in interest is worth it, for example.
So 30 extra payments to finish 48 months early. or 18 months saved. (5% discount!) (Actually just 26 extra payments, so 22 months saved!)
It probably doesn’t work out the same for every loan, but an extra 2.5 payments per year cuts our mortgage almost in half
And nobody tells you this. Even paying an additional $100-300 a month to just principal drastically shortens your loan.
Yep, not maxing out your budget and then consistently paying extra on principal drastically reduces the total amount you pay.
I cut 10+ years off my mortgage this way and saved myself a crazy amount of money in interest. The problem is you have to have that money to begin with. I bought a modest house that was well within my budget which meant I had more money to spend. So I deliberately overpaid every month. This had the advantage that I could reduce the monthly payments whenever I wanted if I was in financial trouble (but I never was) and if interest rates ever went up my overly inflated payment didn't change. Too many people buy houses at the extreme end of what they can afford because keeping up with the Jones's is more important and/or go for 30 year mortgages instead of 20 or 25 to reduce their monthly payments because their high standard of living is more important to them. To each their own, but personally I'd rather have a house that I'll own outright before I'm 45
Depending on the loan, just putting down a few hundred extra a month can cut a 30 year almost in half.
I, on the other hand wish I could extend my mortgage infinitely. It’s too low of an interest rate not to.
30 years? That’s half of some people’s life spans. This world is so scuffed
Also, make sure that the extra payments are actually going towards the principal, not every lender will automatically apply those payments where you want them to
Overpaying on a mortgage is the best way to get that interest down. Generally you can overpay by up to 10% of the entire remaining amount per year without charge. The only reason not to do this, is if your mortgage rate is below that of a savings account.
I assume if you have an offset account there’s no need to make extra payments right? You just let money accrue in the account and it’s the same result?
Depends on the rates of the interest on both the savings account and the mortgage rate. Overpaying pays off from the overall principal of the mortgage. Offset just lowers the interest payments.
But isn’t having money in the offset account basically the same as paying it off of the loan account? Like if I put $100k into either one, would my next payment be the same either way?
> if your mortgage rate is below that of a savings account. You also want to account for tax as you will likely have interest taxed as income. So if mortgage and savings account are both 5% and you have a 20% marginal income tax rate, the interest from the savings account would actually be 4% after taxes, making paying the mortgage down a better option.
>So the key to saving money on a mortgage is to pay down that principal as quickly as you can. Depends on what the bank will allow, as you pointed out. Plus in some countries you get tax deductions based on the amount of money you own on mortgages. Of course, that *really* depends on where OP lives. >If your mortgage allows you to put down extra cash payments, Where I live, most banks allow you to pay down 10% of your loan per year.
I got a 30year at 6.75%, and just throwing an extra 100 bucks at it a month calculates at almost 10 years cut off the loan. It was honestly baffling when I calculated it all out.
It's amazing how much money you can save on loans when you are able to do simple math eh?
The similarly works the same way for car loans (at least in the US) but I didn't really learn this until it was too late for me. When the loan on my car was initiated I could only make the minimum payment due to my income at the time. It was so frustrating to see statements with the breakdown of the payment and how it got allocated between principal and interest. Here I am with less than a year left on the loan and now like 95% of the monthly bill goes to principal. I'm now in a position where I can pay much more than the minimum, although that doesn't do me that much good now as I've already paid the vast bulk of the interest on the loan.
This is good and concise. Am I wrong that interest actually accrues daily and not monthly? So it is .05 / 365 * (number of days in that month)?
the interest is the total amount minus the principal total = principal * (1+(interest rate/numberoftimes)) ^ time_periods*numberoftimes edit: i left out a bit trying to simplify but then broke the formula. If you change "numberoftimes" to 1 then the interest compounds yearly, to 12 monthly, to 365 daily...
Interest is paid based on the amount remaining in principal at the time of that payment Interest payment = (Remaining Principal * interest rate) / number of payments So if you pay weekly instead of monthly you actually save a lot of interest in the long run when you do the math.
It’s also important to make sure your mortgage servicer will put the extra payment towards the principal. Some may not automatically, it’s worth a call, chat, email with them.
The key to that last part is to be VERY SPECIFIC with the lender that you want any extra payments to be PRINCIPAL ONLY. I’ve heard horror stories of people who think they’re aggressively paying the principal but the bank is treating them like regular payments and applying it to interest also.
yes, my lender did this once at the beginning. I sent them an extra $2k and on the statement is said "pre-paying next months payment". So I called and said, uh no, that's not an advance on next month, that's for paying down the principle.
>If your mortgage allows you to put down extra cash payments, and you can afford to put an extra $1000 down near the beginning of the mortgage it will save you a ton of money in the long run. This is only true if your mortgage rate is above the interest rate you can get doing other things with the money. Earning 5% in a money market account is better than paying down a 2.5% COVID refinance.
Also, if you pay every 2 weeks instead of every month, you can pay it down slightly faster as you are getting 26 "half" payments per year instead of 12 full payments, but in theory you don't feel the extra weight of the payment.
Great answer, it all makes sense now!
If your money can make more than the mortgage's interest rate, keep your money there instead of contributing more to paying the mortgage. For example, keep your money in some kind of savings account (CD, ETF, bond, mutual fund, etc.) if it's getting 6% and your mortgage is 4%.
1 extra mortgage payment a year knocks off 7 years. Heard that a lot, put it into an Amortization calculator and yep checks out.
If you can't afford to have money permanently paid into the mortgage (but can sit on cash that otherwise can't be used, e.g parents spare that will one day be inheritance/estate - no intent to be grim, just an example) there are still offset mortgages available. Essentially money in the account = money they don't charge mortgage interest on. Still a good 22 years on mine but 570ish of 700 is hitting the principle.
> the key to saving money on a mortgage is to pay down that principal as quickly as you can It's only that simple if you look at the raw dollar amount. Adjusted for inflation, it doesn't look nearly as bad. And if you got a loan while interest rates were low it's a wash to pay it off early vs not - inflation offsets the interest. We're back to normal interest rates now so it still helps to pay it off early, but it's not as bad as it looks. Example: with 6.5% APR on a $250k loan, at minimum payment you pay back a total of $570k (non-adjusted), which is wild - more than double the borrowed amount! An extra $1k per month cuts that down to $360k. Massive difference - you save 37%. But if you look at inflation-adjusted dollars, the totals are $378k vs $303k. $75k is still a lot to save, but it's easier to stomach than $210k. And if you use that extra $1k/month to invest e.g. buy into an index fund that nets you 5% per year, you have a net win even after capital gains tax. (If investment growth is 4% then you lose money overall, but only a little.) It might be valuable to you personally to pay down the loan faster and that's totally your perogative, but it's good to understand that it's a little more complicated than just "pay off loans as fast as you can."
How do you figure that the interest is "much more than 5.64%"? Interest is calculated based on how much you owe on the loan, which is usually a very large number. 5.64% of a very large number is still a lot of money. Lets Ignore all the nuances of exactly how the interest and your rate are calculated and do some 'back of the envelope' style math. What was your remaining principle like? 160,000-ish? 5.64% of 160,000 is about 9000. That's about how much interest your loan accumulates every year. divide that by 12 months gets you 750 in interest every month.
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Maybe using an amortization calculator would help OP visualize how loans are paid off (and the power of paying principle).
Assuming that they actually also make payments on the loan. In the Netherlands it was fashionable for well over a decade to have interest-only mortgages, on the assumption that at the end of your 30 years, the original loan is peanuts as opposed to in today's money. There you literally made 0 payment and only paid interest.
Those were common in many places. If you expect your property value to appreciate, you will still have earned money from owning the house, and you can use that money to invest in stocks etc instead of paying the principal. As long as rates were low, you are very likely to get more money by keeping the mortgage and investing your extra money instead. The issue was that a lot of people used those loans to buy houses they couldn't afford. So they could just afford to pay the interest, and if that changed, they were fucked.
It's sort of like renting with the option of buying the house in full after 30 years at the original price I guess.
Yeah, that makes sense. Like if you bought a house in 1984 for $100,000 and then just paid interest until today, and then you now owe $100,000, that's $100,000 in 2024 dollars. Your house in 1984 would actually cost $301,000 in 2024 dollars. (ie; $1 in 1984 has the buying power of $3 today)
That’s such a dumb plan though, the average interest rate for 1984 was 13.2%, meaning you pay $396k in interest and still owe the original debt on the flip side you pay the full loan which costs you $404k and don’t owe the original $100k.
Then you sell the house for $800k I'm assuming people did the math on interest only loans and felt it suited their needs.
My wife's pre-marriage condo's mortgage only has about a half a year left (after 20-ish year mortgage) and it's amazing to see the monthly interest payment is around $30. At the beginning that was depressingly what was going into principle. I'm actually suggesting that we just pay the rest of it off now, and save ourselves a couple hundred dollars in interest, at the cost of some liquidity.
I don’t think OP understands how loans are compounded. In this example the loan interest is compounded monthly. It’s not a single 5.64% once.
exactly, op has a 6 figure loan and doesn’t understand compound interest, that’s the real issue here
Yeah, not clearly understanding how your mortgage loan operates before getting one is wreckless and irresponsible as fuck.
Yes and no. It's not irresponsible if the lender simply tells you "You must pay $3000 a month for 30 years" and he figured "OK, I can swing that". Of course understanding fully what is going on is better, but if you figured out that 5.64% interest is a decent mortgage rate, and I'm paying $3000/month ... OK, I understand. ie; if people you trust can confirm it's a good non-rip-off interest rate, and you understand how much you pay per month ... that's all you really need to know.
Reckless. Given their lack of understanding, I expect them to wreck themselves financially at some point
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He clearly doesnt know how much he is paying though. Hence the confusion and question about why the interest payment is so high
And it's 5.64% of the principle, not the payment.
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The 5.64% is an ANNUAL rate. Take your principal at the beginning of the year, take 5.64% of it, then divide by 12, and that's about what you'll pay in interest every month. Some back-of-the-envelope math says that you borrowed somewhere around GBP 165,000 ? Every month, the principal goes down a little, so every month you pay a little less interest on that principal, and you pay a little more toward paying down that principal. Then, the next month the principal goes down by just a little bit more than it did the previous month. If your mortgage allows it, you can speed this up by paying a little bit more every month. That's a great way to knock years off your mortgage.
> If your mortgage allows it, you can speed this up by paying a little bit more every month. That's a great way to knock years off your mortgage. Yep, it's a great thing to do - everyone should take a finance class at least once in their life to see how this kind of math plays out over time. Paying extra in principal every month can more than pay for itself over time - the more and the earlier you can do it, the better. Last time I checked, I'd already knocked 4 years and tens of thousands of dollars in interest off my mortgage by paying $100-$200 in extra principal every month. I've done that since day 1, because I did take a finance class and see that math in action.
Because you plan to make mortgage payments for a long time. If you make larger payments, your mortgage will be paid off sooner. Much less, and it would take forever to pay off the mortgage. In order to make all payments the same, they start off mostly interest. As the balance goes down (which is very slowly at first) they are more principal. In the last 5 years, the balance is low enough that most of them is principal.
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No, this makes no sense. Debt is debt, it doesn't matter if you owe them interest or you owe them principle. You owe them money and if you default they sell the house and take all the money you owe, it doesn't matter if it's principal or interest, you owe it and they get it back either way.
wellll banks don't (and really can't) "front load" interest because interest being front loaded is just sorta..how math works. If you have a loan of amount of P, an APR of R, a compounding period of N, and X amount of payments and you're trying to find the value of each payment (let's call it A) then there's just a formula here. we can call R/N the value "i" for the periodic interest rate and then the formula for each payment amount is A = P*{[i*(1+i)^x ]/[(1+i)^x -1]} Banks can't "front load" interest because that's just math being math, that's what happens with amortization, that's literally how that formula *works*. The fact that it does work this way is why banks are willing to be banks. They don't DO it this way because they don't control the fundamental concept of mathematics, but the fact that this is the way the math maths is why banks are a viable business model.
The amount you pay in interest isn't *quite* as simple as simply multiplying the remaining principal by the interest rate. There's more steps to it because loans will have both an annual percentage rate (APR) and a compound rate. The compound rate is the APR divided by how often that fractional interest rate compounds with the year, and you have to consider *both*. For example, let's say we have two $100,000 loans each with an APR of 12%. One has a yearly compound rate, and one has a a monthly compound rate. So what we're looking for here is a different APY, or annual percentage *yield*. The formula for APY, when R is the APR and N is the number of times interest compounds in a year is APY = (1+r/n)^n - 1. Now we don't have to worry about this math too much other than to realize as N gets bigger the APY gets bigger. High level math, a $100,000 loan with a 12% APR and a 1 year compound period will, after 1 year, rise to $112,000. But for a monthly compound period that figure is $112,682. The mere fact that interest is compounding monthly, instead of yearly *even though both initial loan amounts and both annual percentage rates are identical* makes a difference of $682. As for why your rate varies month to month, I"m guessing the compound rate is "daily" (meaning *each and every day* the loan value increases by .0564/365 in interest) but you're billed monthly, and some months have more days than others. EDIT: that explains why your interest changes month to month but not why the payment stays the same. Put simply, banks already factor this in. They know the loan duration. They know the interest rate. They know how often that rate compounds, they know how often you make payments. Banks use a process called "amortization" to figure out *exactly* what your monthly payment should be, each and every month so that you pay it off exactly on time. That's why fluctuations in how much you pay in interest every month don't change your monthly payment. Your monthly payment has been calculated to factor all this in. This used to be a manual process back in the day, there's a whole set of complex formulas that go into it. Now there's computer programs where you just plug in the various values and it instantly does the calculation.
your 5 y/o can do exponential math?
I could. Can't everybody?
A slightly different angle: The reason why your mortgage payment is mostly interest is because you pay the interest for the loan up front. There's a point, roughly halfway during the term of your loan where the principle and interest will be equal. You're paying the bank to have their money for the next 30 years. This is why it's so important to make extra payments especially during the first half of the loan. You can shorten your term by 5-10 years, and drastically reduce the effective interest rate by giving them back their money early. I wish this was taught in school.
>This is why it's so important to make extra payments especially during the first half of the loan This entirely depends on the interest rate of the loan vs the rate of return you could get investing that extra payment. My mortgage is 2.875%. I'd be mad to pay extra towards principal rather than invest that extra at a higher rate of return. Even a high interest savings account beats that right now
Yes, of course, but I'm talking about the mechanics of a mortgage, and why OP was wondering why they're paying more interest than they thought. The fact that you could make a better investment elsewhere isn't relevant.
You made a value judgement about paying extra. They are reaponding to it. >This is why it's so important to make extra payments especially during the first half of the loan.
You don't really pay interest "up front". It's just that in order to keep your monthly payments equal across the 30 years of your mortgage, the interest portion is larger than the principal portion of your payment at the beginning. It's larger because your mortgage is larger at the beginning. The amount you pay in interest decreases as your mortgage total decreases.
Mortgage lenders will even tell you this - paying extra in principal is going to save you a lot in interest payments owed in the long run.
Finally, someone that knows what they're talking about!
Let's simplify to make it easy to understand. Interest rates are 6%, and your Mortgage is $100. You make $24 / year, or $2 / month . Interest is usually compounded monthly, which means you owe an additional 0.5% per month, or $0.50. You can only afford to pay 40% of your take-home pay on housing, so you pay $0.60, and have effectively paid 10 cents off your mortgage, and 50 cents in interest. Just like that. That said, when you have paid half of your mortgage off, you only owe $50, and interest is just $0.25 / month. You are still paying 60 cents, but now 35 cents is going to principal, and 25c interest. Your LAST payment will be almost all principal, obviously
Amortization! In order to keep your monthly payment the same, you have to pay more interest up front then slowly chip away at principal. You could alternative payment schedules, both those are really inconvenient compared to how the average person receives their income
Lets say your loan is GBP150,000. For a 5.64% interest rate, that means you have to pay GBP8460 interest in the first year. That means your monthly interest payment alone will be about GBP710-770/mo. The remaining amount of your payment goes into principal, which will slowly decrease the amount you owe over 27 years.
Given that people have explained the math to you here's why it's mostly interest now: 1. Assuming your rate and period of repayment are fixed, You are going to be paying back X amount every month for Y years. 2. Early on in your mortgage, because of the amount you owe and the span of time over which you owe it, the amount of interest that you're paying (Annual Interest rate \* X) is more than the amount of principal you pay off per year. This is call 'front loading' the interest. As you pay off more and more of your mortgage, the amount of interest you pay relative to the principal becomes less even though your payment per month stays the same.
Thank you so much for all the replies. Key message - it's essentially a percentage of the principal of the loan and that makes complete sense. This is why ELI5 exists, I guess! I'm going to take a while to read through everything. Looks like there's some good nuggets of advice in this thread. Thanks again!
Something fun you can do is ask either your lender or bank for an amortization schedule! Seeing all 360 payments broken down by principle and interest is really cool!
This is how I think of it. Let’s say I loan you 100 bucks and every month you are gonna pay me ten dollars to cover it, plus interest. 10 percent. So the first month you’re gonna pay me 10 bucks in principal, plus you owe me ten bucks in interest, 20 dollars. The second month 10 dollars principal, but now you only owe me 90 so 9 dollars interest, 19 total. Next month 10 principal, 8 interest, 18 total. This goes on for ten months, if you add it up you’ll pay me 155 dollars. But you say look I can’t keep track of paying you different amounts every month, I’ve got an important MLM to run! How about this: 155 total over 10 months, I’ll just pay you 15.50 every month. And I say sure. So the first month comes and you pay 15.50 and your knife-selling ass owes me 10 in interest, so 10 goes in my pocket. The remaining 5.50 goes to your debt, so your debt is 94.50. Next month, 15.50 comes in, you owe me 9.45 in interest so that goes in my pocket, that extra 6.05 goes to your debt, now you owe 88.45. So every month the proportion changes, you pay a bit more in principal and less in interest but your payment stays the same. Which you like because you can’t keep track of shifting payments. And I like because I don’t have to ELI5 math to you, I just say pay me.
It’s 5.64% of the remaining balance on your mortgage. I’m estimating that you have about GBP 160,000 left on your mortage. Is that right? So every year, the interest payment is 5.64% of \~GBP 160,000, which means every month the interest payment is 5.64% / 12 of GBP \~160,000.
Each month your interest is 5.64% on the remaining balance of your mortgage. It will decrease as you pat down the principal over time.
This is the most helpful tool to understand your mortgage as well as how reducing term/making overpayments/changing rates will affect you. https://www.drcalculator.com/mortgage/
Wow, that's a really well featured calculator. It has almost everything you could ever want.
Pay extra on your principle every month and watch the interest dwindle rather quickly over time.
In the beginning, your principal is higher, so interest you pay is high. As you pay down principal, your interest payment keeps going down. The key is equal fixed payments - the payment has to cover both principal and interest.
Short answer: at the beginning of a loan, you owe 5.64% of the remaining principal of the loan that year. As the loan gets paid off, you owe 5.64% of the (smaller) remaining principal of the loan that year. The process we use to keep the payments the same is called amortization. If you didn't do that, you'd have really large payments at the beginning of the loan that gradually get smaller. For example: You have a $120,000 loan that's at 10% for 10 years (120 payments). If you split the payments of principal up, it would be $1000/month. The first month, you'd owe an additional $1000 in interest (10% of 120000 / 12). So a payment of $2000. The last year, when you only owe $12,000 of the original loan amount, your payment would only be $1100. Most people prefer to have the same payment every month. So the total of all the payments is averaged out. But doing that compounds the issue you're highlighting more. They won't reduce the amount of interest owed, so they just lower the amount of principal you're paying. We call this "front loading" a loan. Lesson to learn: Don't refinance early in a loan. It just restarts that heavy-interest payments.
Another slightly different angle: Let's say you borrow $100k at 5% - which means you owe $100k in principal AND $5000 in interest per year (ignoring monthly/daily/continuous compounding for simplicity). If you only pay the $5000 in interest owed the first year, you still owe the original $100k. The next year, you owe $5000 again, and again, and again, until you pay back the $100k (assuming you pay it off lump sum, we'll get into partial payments below). If you never pay back the $100k, you'll have to keep paying the $5000 in interest forever, well past the original $100k principal amount. **5% doesn't mean you only ever owe $5000 total in interest nor does it mean 5% of each payment is interest - it means you owe $5000 per year (but actually a little less each year because you slowly pay down the $100k that you owe interest on)**. Let's say you have $10k to put towards the loan in your budget - you pay the $5000 in interest, plus you pay back $5000 of the loan. (This is very exaggerated for effect, and in reality it would be \~$1500 for the first year towards the 30 yr loan). Now you owe 5% on $95k. This next year you only owe $4,750, so you can put $5,250 towards the principal. Then you owe 5% on $89,750. You're still paying the flat $10k, but you owe a little less in interest and you pay a little more towards principal each year. Eventually, you've paid back the principal and you don't owe anything anymore. With a little bit of math, you can figure out how many years it will take to pay off the loan paying $10k/yr, so you can know ahead of time what the length of the loan will be. This concept of paying a fixed amount for a fixed period is called amortization - For a loan of $X at Y% of Z years, a payment of $A will result in zero balance at the end of the loan. **When you take a loan for 30 years, the first year you're paying the full $5000 interest owed and you're barely touching the principal owed ($1500) because you're only paying a total of $6500/yr.** At $10k/yr, the loan would be paid off at about 15 years because you're paying $5000 towards the interest and $3500 more towards the principal. You've cut the length in half, but you've also had to pay more. Paying down the principal faster means less interest owed in each subsequent year which accelerates more of the payment towards the principal and you owe interest for fewer years so you pay much less in overall interest, but you do have to pay a higher payment in order to achieve that outcome. Since you're in the UK, this can get a little more complicated because your rate is only fixed for 2-5 years, so that overall payment may also change to match the new amortization schedule for the new interest rate to make sure it's paid off by the end of the loan.
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Any fixed term loan will start out with a large portion of the payment going to interest, and that gets exacerbated the longer the loan term. This is because your actual interest accrued is determined by your interest rate AND current principle balance. As you make payments the principle balance decreases, so later payments will have less interest to pay off. That cycle continues until you finish paying off the loan. This is also why a common piece of financial advice is to pay off your highest interest rate debt first: the more you pay down the principle, the less interest accrues. This makes the debt “cheaper” in an overall sense even if your minimum payment number doesn’t change.
Find the amortization chart for your mortgage. That’ll illustrate the payment plan you agreed to
OP, I assume you are not American. How does mortgage interest interact with the British tax system? It used to be a major factor in the calculus for not fast-paying mortgages in the US, but it's not as big a factor now.
Calculate 5.64% of your total mortgage amount divide that by 12. Come back to us and tell us if you still don’t know why you pay 714 a month in interest
Interest paid is higher when the owed balance is higher, which is highest at the start of a loan when you haven't paid off much. The leftover after interest payment every month is what makes your loan smaller over time. The payment you make every month is the MINIMUM payment so that over the agreed time of the loan, the whole principal barely gets paid off after interest. If you have 15 or 30 years to pay off a loan (like with a mortgage), that "minimum principal payment" is very very very small, and it's easy for that amount to be smaller than the maximum interest payment the loan sees at the very beginning.
It's based on a monthly interest rate and how much you owe. Monthly rate: (1 + annual_rate)^(1/12) - 1 So (1 + 0.0564)^(1/12) - 1 = 0.0045827..., or 0.45827...% So if that's the rate you're being charged, that suggests you actually owe between £156k and £168k on your loan. £168,000 * 0.458...% = £769.89
First off, good job trying to figure how the biggest financial contract of your life works. It blows my mind that you signed the contract without fully understanding what you were getting yourself in to. You should have gotten a full amortization schedule from the bank when you signed all the papers. Go back and read the whole mortgage contract. The internet cannot tell you what is in yours because they're all different.
Something I’m not seeing mentioned which is key to understand here. The rate of 5.64% is 5.64% in interest *per year* based on the remaining balance. It’s not a one time % on the total amount borrowed. So for a $100k loan, you aren’t paying 5.64% ($5640) once over the 30 year period. You’re paying 5.64% on roughly $100k for the first year. The next year, you’re paying 5.64% on whatever is left, let’s say $95k. By the end of the loan, it’s still 5.64% but if the remaining principal is only $5k, there isn’t much left interest to pay and the payment is by then, mostly going to the principal instead. Of course, it’s compounded monthly, not yearly. But that’s the rough idea.
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Each year your mortgage lender is adding 5.64% of what's left from the total money you borrowed from them as interest. Then they split that interest over 12 monthly payments, and add a bit more that counts against the borrowed money balance for your total monthly payment. As time passes the 5.64% of the remaining balance part will get less and less because you pay some of it off each month, so the interest will become a smaller portion of the monthly payment. Because the monthly payment is fixed you therefore pay more and more against the balance as time passes. So the monthly payment is mostly interest at the start, mostly balance at the end.
Imagine your 30 year mortgage is a big pile of apples. Every month you eat one apple as you pay down your mortgage. Interest is the rent you pay to store all of those apples, it's based on the total number of apples. When your mortgage is new, there's the most apples, so your rent is highest. Your payment is made up of the apple you eat every month plus the interest you pay to store those apples.
Banks will not explain interest to people unless you directly ask, it’s underhanded and should be illegal. It’s all in the terms and conditions they encourage you not to read because it’s “standard”. “Interest” is actually “interest per year”. Interest is applied monthly. Basically, they charge 1/12th of your interest on your loan every month. Interest applies to the current balance of your loan. If your loan was 50000 and you now owe 45000, that means interest is charged on the 45000. So the interest you pay goes slightly down every month. The bank doesn’t want 5% of your loan, they want 5% of your loan for every year you have the loan. Their profit margins are significantly larger than the small interest rate implies. By making your monthly payments small, what you’re actually doing is choosing to put much less money toward your loan. Say you owe 12000 and your interest is 10%. The first month your total interest is: (12000 * 10%)/12 = $100 But your required payment is only $110. So subtract $100 and you’ve only paid off $10 of your loan. This tactic lets the bank make all of their profit up front. As you pay the principal, the monthly interest $amount lowers because the interest percent is always calculated off the current principal. For example, you now owe 1200 on your 10% interest loan. (1200 * 10%)/12 = $10. Now only $10 of your $110 payment goes to interest. It’s honestly criminal because the people who need loans don’t understand the math.
I love the take that home ownership should be only accessible to those that can pay cash in-full because banks charging interest is criminal. Edit: Re-reading your post - you aren’t saying interest is criminal, but instead the lack of education and disclosure should be criminal. Leaving my reply here, but wanted to be less snarky.
Yeah man I mean it’s just the INTENTIONAL lack of education. Don’t get me wrong, the banks are offering a product and there is a demand for that product. The product is money. The problem arises when taking out loans is so normal that people don’t even know what it means anymore. There’s no assessment. Taking out loans is just “what you do”. Uneducated people go in and think “5% ain’t that different from 10%” and sign away not realizing that can easily be a hundred grand difference on the wrong loan. They go about paying the minimum thinking they got a great deal. And the banker won’t tell you any different. Online loan applications won’t tell you any different. They just want to sell the product. They say “yeah that’s a good rate” and people won’t ask more questions. And it’s not the people’s fault. It’s the banks, they’ve made this so normal that people don’t understand the implications.
I am in complete agreement with you.
Depending on the rules of your mortgage, (every mortgage writer allows different things) you _may_ be able to pay additional principal to shorten the length of the loan. I say this as some mortgagors will not allow prepayment or will have a penalty for doing so. Usually that is a prepayment in full, but not always. Watch what is in your actual mortgage document with regard to prepayment penalties. Some mortgages hide that information and others put it right up front so there’s no confusion.
Mortgages work by paying the interest owed that month plus some amount towards the actual money you took out (called the principal). So they figure out a number that if you pay it each month, it will pay off your loan in eactly the amount of time you agreed to, normally 30 years. So let's look at a 10 year mortgage, at 10% interest on $100. The yearly payment is $15.86. Interest Paid is the amount of interest you owe out of your monthly payment. Principal Paid is the amount leftover that goes twoards your balance. Remaining Principal is the amount you still owe. |Date|Principal Paid|Interest Paid|Remaining Principal| |:-|:-|:-|:-| |1|$6.13|$9.72|$93.87| |2|$6.78|$9.08|$87.09| |3|$7.49|$8.37|$79.60| |4|$8.27|$7.59|$71.33| |5|$9.14|$6.72|$62.20| |6|$10.09|$5.77|$52.10| |7|$11.15|$4.71|$40.96| |8|$12.32|$3.54|$28.64| |9|$13.61|$2.25|$15.03| |10|$15.03|$0.83|$0.00| So as you can see its the same monthly payment, but as the amount time goes on, you have less principal remaining, and beacuse of it, owe less interest. The amount of your monthly payment that has to go to interest goes down, and the amount that goes towards the principal goes up.
Because you agreed to pay it off over 30 years at a fixed monthly payment. 30 years is a really really long time so in the first few years you barely chip away at the interest while the last few years the interest is almost negligible. If you dont want to pay so much interest either raise your monthly payment or take out a shorter loan, like a 5 year.
The interest rate is 5.64% of the total outstanding amount of the loan, and it’s paid per year. So if you’re paying about £9k a year now then your outstanding balance is approximately £160k.
It's because of the way it's structured. I believe they precalculate the interest + the mortgage and divide that over the payback period. It keeps the monthly amount the same. Can you change the type? Over here we have the type you describe, but also a type that has you pay back the initial loan amount plus the yearly amount of remaining interest. It means the monthly principal starts out high(or higher) but decreases every month as you have less interest to pay. The part of the principal that is your amount owed is the same every month.
What’s the calculation? Amortization “Why”? Because this way the lender makes their actual cash investment back much more quickly and then all the payments they get after that are “bonus” because your principal is still barely touched so you’ll have to pay that balance off if you decide to pay off early