Nothing beats a lower interest rate

Roger Schlesinger
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Posted: Apr 09, 2007 9:53 PM

An interesting thing about lower interest rates is that not only is the payment lower, but the amount that goes to principal is larger and the amount that is paid as interest is lower. On a $200,000 loan if you have an 8% interest rate the first payment is made up of $134 of principal and $1333 of interest, on a loan amortized over 30 years. If you have a 6% rate on the same loan, the first payment is $199 of principal and $1000 of interest. You obviously see how much the difference is in the total payment and how much more goes to paying down the mortgage. If you were to take the 6% rate and make the 8% payment you will end up with a much larger principal payment and actually pay off your mortgage in a bit over 19 years.

If you understand the relationship of interest to mortgage payments you have the ability to adjust your payments to work in the best possible way for you.

An example of the above statement comes from a question I received from a borrower.

He said he was in a 30 year fixed that he had been in for 10 years at 7.25% The payment is $1381 per month, and has a current balance of $175,000. The loan will be paid in full in 20 more years A 15 year loan for $175,000 in the high 5% range is $1464 which is a bit higher payment than the current mortgage. The comparison of principal and interest between the two loans shows the following: 30 year principal payment is $274 and $1106 will go to interest. The 15 year principal payment is $608 and its interest payment is $856.

The cost associated with going to the 15 year is $83 a month or $4980 over the life of the loan. The savings is 5 years of payments equaling $82,860. .

The lesson is that the longer you pay at a higher interest rate, the easier it is to refinance to a shorter amortizing loan with a lower interest rate and save money over the life of the loan by shortening the number of years you need to payoff the loan. In many cases you can also save on a monthly basis as well.

Now what about credit cards? The new rules have the card holders paying one percent of the outstanding balance each month plus the interest. Assuming a 9% interest rate your payment would 1.75% of the balance. On $30,000 your monthly payment would be $525.00. If the interest rate is 18% your payment would be $815 per month. If your interest rate was 24% the payment is $900 a month. If you were to take a second mortgage or Heloc your payment will not only be significantly lower but you will receive a tax deduction for the interest in most cases. If you stay with the credit cards not only will you not get a tax deduction for the interest on your credit cards, you will have to pay the bill with after-tax payments (See "It Simply Costs to Much" March 28, 2007)

Although I spend a great deal of time trying to show people how they can face their finances in a better, more intelligent manner, many people feel that "if you make your bed you need to lie in it". The critics seem to focus on people who have credit cards primarily, but are also very skeptical of anyone who is in serious debt. Not only do I disagree with that attitude I think it is counterproductive. There isn't any reason to stick with your credit cards if you can do better elsewhere. From my desk I see the causes and results of debts, whether they are "needed" such as medical care, or "frivolous" such as a family vacation to a nice resort.

My answer is simple. My mother told me to dress warm when the weather was cold. If I didn't and caught a cold, no matter what actually caused the cold, she treated me the same as if I had caught the cold from my brother with whom I shared a bedroom. Life is tough enough without sorting out cause and effect and taking action based on your deductions from the equation.

There are a few don'ts that I think are important to remember. Don't punish yourself, don't disqualify yourself, don't belittle yourself and do not ever be embarrassed by life's accidents that put you behind the eight ball. On the other hand, don't be casual about your finances. "I do not know anything about ----" doesn't get you a pass if you fail to take the time to find out about what you don't know before you act on that situation. Too many people take the wrong mortgage, either one that won't help them reach their goals, or one that will take them backwards in their finances, and when questioned about it just plead ignorance.

It's your money and your finances so it behooves you to learn about the subject before you move forward. How do I know this is going on? By the number of option arms that have been sold to unwary borrowers who haven't a clue that the loan is negatively amortizing or even what that means.

It is truly up to you to make every effort to understand everything about finances before you do anything. The mortgage industry is definitely what the phrase "haste makes waste" was referring to.