Effects of paying Extra Principal repayments at the Beginning of the lifetime of a mortgage

Elaborating more on the idea that a 10K saving is not a drop in the ocean when it comes to investing or in the wider scheme of a large mortgage.

The below illustrates the importance of making extra repayments on top of the principal repayments of a P&I mortgage at the beginning of the lifetime of the loan and how much it can save in interest.

All three scenarios below are for a 30 year 500k loan @4.5 % interest rate that starts on April/2019

Scenario 1:
no extra repayments:
Amortization Schedule for the first 3 years
Date Beginning Balance Interest Principal Ending Balance
Year 1 $500,000.00 $22,334.98 $8,066.18 $491,933.87
Year 2 $491,933.87 $21,964.44 $8,436.72 $483,497.18
Year 3 $483,497.18 $21,576.84 $8,824.32 $474,672.91

Total Interest $412,033.56

Scenario 2:
Double the Principal repayments at the BEGINNING of the life of the loan:
Amortization Schedule for the first 3 years
Date Beginning Balance Interest Principal Ending Balance
Year 1 $500,000.00 $21,995.94 $16,471.40 $483,528.65
Year 2 $483,528.65 $21,223.66 $17,614.22 $465,914.49
Year 3 $465,914.49 $20,398.20 $18,827.28 $447,087.25

Total Interest $350,277.71 ( $61,756 of interest saved)

Scenario 3:
Double the Principal repayments of the first 3 years of the loan close to the END of the life of the loan:
Amortization Schedule for the years 2044 to 2046 years
Date Beginning Balance Interest Principal Ending Balance
Year 26 $135,891.43 $5,268.85 $33,198.49 $102,692.99
Year 27 $102,692.99 $3,728.16 $35,109.72 $67,583.31
Year 28 $67,583.31 $2,098.95 $37,126.53 $30,456.81

Total Interest $407,782.67 ($4,251 of interest saved)

So based on the above, doubling the principle repayments at the beginning of the lifetime of the loan provides a massive financial benefit via saving on interest. The benefit occurs at the beginning of the life of the loan simply because the Interest part is much larger than the principal part of the repayment

So roughly paying an extra 8000$ a year for the first 3 years gets a cumulative benefit of 61,756$ , equating to roughly 662.50% ROI or an annual return of 97.895%

Looking at it differently, if i work an extra job to make this extra 8000$ , my hourly rate would be pretty much double of what it actually is.

Hope the above makes sense and please correct me if i'm wrong on any of the above as i'm not accountant or anything like that. I'm simply trying to make sense out of the numbers ...

PS: I used this calculator to help with the scenarios Mortgage Calculator

 

Your Interest rate is 4,5%, p/a. So therefor your annual ROI for the 8k extra you pay must be a poor 4.5%. You have paid $24k (3x8) for a return of $ 62k, or just 38k gained after 30 years later. . You have not accounted for an alternative use of your $24k you should be able to get a better return than that any where else in just 1-10 years. And pay the house of much quicker with earning from a superior allocation of your capital.

 

Also, $24,000 (3 x $8,000) is worth a lot more today than it does in 26 years time .

 

Some good points but I should have been a bit more specific with my post. It's more about the benefits of paying extra payments at the beginning of a P&I loan and how much that can save in Interest over the lifetime of the loan. More of a scenario for PPOR owner i guess.

A few things about what you are suggesting(investing that 24k somewhere else):
It's not risk free and it's taxable, while paying off the mortgage and saving on interest is both risk free and not taxable.

Also , starting with 8K and adding another 8K over 10 years at a 10%(don't think many assets can achieve that rate these days...) return rate will end up making you around 60K and again you have to pay tax.

On the other hand, If you end up paying 8k on top of your principle every year for 10 years, you'd be saving around 141K over the life of the loan.

I think we are arguing two very different scenarios here.

 

Make a post showing how to save or make 500k and I will start to get interested. This is still a drop in the ocean.

 

You may be missing the bigger picture. Removal of the non income producing non deductible debt ahead of schedule is worth far more than just the X amount of interest saved because you've paid it off in 15 years instead of 30. It's a mistake to look at that as a 60,80 or 100K win. Removing the debt provides accelerated access to equity and accelerated access to the borrowing power required to make use of the equity, far earlier than would otherwise have occurred . This in turn allows for opportunities to be acted on earlier than would otherwise have been possible. What value do you place on that? What you should be considering is the total effect of paying down PPOR debt faster, rather than just the dollar value saved on the PPOR mortgage .


Imagine for example you had purchased a PPOR in SYD or MEL between 1995 and 1998 , and had paid it down in 15 years, so were debt free by 2010 - 2013. The ability to take advantage of an unencumbered PPOR in either big city while there were pre APRA servicing calcs and pre APRA cash out rules in play would have enabled an investor to build a very large portfolio that wouldnt be possible today even with the mythical 500K growth you are seeking.

Now compare that to someone who still has 12-15 years remaining of their PPOR mortgage, and is using todays servicing calcs and cash out rules - your 500K benchmark would be useless to them by comparison

I know this for a fact, because I did it. I am a real world example of what accelerated debt reduction can do for someone. In 2008 I purchased a modest PPOR in Merrylands for 375K. I paid off that PPOR by 2013, then drew out 80% of its then 840K value in 2013 to fund deposits and stamp duty for a 15 property portfolio that's currently worth over 11Million and will pays itself off in 15 -20 years and leave me with a 500K + net income stream in retirement

I was able to secure 90 or 95% LVR lending on IO terms for 10 years at the time, for each purchase - all underpinned with NRAS tax credits for 10 years. Cant get those sorts of LVR's now. cant get long term IO now. Cant get 10 year NRAS credits now.

I was able to borrow @ 6 Million on those terms.... Cant get that now either.

Imagine if I hadn't paid off that PPOR and I still owed 250K or 300K on it ... even if it had gone up another 500K or $1 Million in value, what good would that do me if I was trying to access 90% or 95% cash out now, and $6million in total lending now..... ??? Absolutely no good whatsoever is the answer. I wouldn't get close. Do you see what I'm getting at? Accelerated debt reduction created the opportunity for everything that followed. It's that simple. And given todays servicing calculators, its even more important than ever to pay down debt now.... which is why I migrated over 50% of my loans over to P&I after 2 years - forfeiting 8 years of the 10 years available to me... because I realise that's what servicing policies require now in order to grow.

People can fascinate or focus over making 500K profits once, maybe twice or even three times if they are lucky... although I do think it's almost delusional seeing how few people managed it when lending was a free for all and "cycles" of growth could be relied upon.... I choose to focus on an income of over 500K every year... NET... without ever having to sell anything if I choose not to.... and I wouldnt have gotten close if I hadnt paid off the PPOR fast.

Debt Reduction - especially non income producing debt like car loans, HELP debt, personal loans, credit cards and PPOR mortgages - is the best thing anyone can do to improve their long term borrowing power, holding power and wealth creation opportunities...

 

Too slow for me. I like making big money and turning it over quickly.

Just being honest, sorry.

 

Do you mind letting us in on how you make big money and turn it over quickly?

 

It only happened a few times with property booms and business ventures but I enjoyed the rush of the experiences tremendously.

I think deep down everyone likes fast money, no?

 

Large CGT's resulting in large one-off tax payments vs normal taxation on income.

 

I like making permanent, never ending big money, rather than fast one off's. The one off's are nice for sure - but they are going to be few and far between for resi property investors moving forward ........

Paying off debt faster by making extra repayments remains sound advice for the forum's readers...

 

Guaranteed result vs somewhat speculative.

It's impossible to truly quantify and the right answer is going to be different for different individual risk profiles.

 

Instead of paying an extra $24k ($8 x 3) into the loan, put into an offset instead. You get the same benefit, but if you find a better use of your $24k it's still available for you to use.

 

Nothing wrong with offsets at all, but ultimately the loan needs to be reduced to see improvements to borrowing capacity. We should remember that extra repayments are still accessible via redraw as well... but they improve borrowing power where an offset balance does not

 

I’ll take whatever I can get

 

Exactly what I've been doing for the past 5 years against my PPOR loan with pretty much half the loan amount in the offset. Plan was always to convert into IP in the future so also has the benefit of maximizing deductible debt when/if that happens.

But i also do agree with @euro73 , I think the current environment is a really good time to reduce debt(non deductible at least...)

 

Why pay off deductible debt if you have equivalent cash in offsets before you absolutely need to?

I do everything I can to maximise deductible debt and stuff my offsets full of as much cash as I can. Hard to create new deductible debt with share investments as there are bugger all expenses.,,. Property on the other hand...

Cash in offsets provides maximum flexibility for non deductible expenses: emergency fund, upgrade PPoR, manage cash low from lumpy business income

 

That is correct, if you've GOT borrowing capacity, but with lending as it is at the moment, you may not be able to get another loan, but if there's sufficient in offsets you can still use the existing loans. Getting redraws can make things a bit messy, and there's no guarantee the bank will allow large redraws.

For instance, we have many loans, and a lot of them are fully offset. We no longer have any PAYG income & we have a lot of paper deductions, so our taxable income is quite low. We are very heavily rent reliant. If I want to purchase another home, I can draw on offsets to do it. I wouldn't want to be asking for redraws for the same purpose, especially as most of the loans are smaller amounts & funds would need to come from multiple different loans.

 

@paulF so you finally understand what compounding interest is.....

It's such a shame many adults still don't "understand" this grade school maths lesson as it is a powerful concept. I'm not being sarcastic just stating a fact about sheeple......

 

"My wealth has come from a combination of living in America, some lucky genes, and compound interest." – Warren Buffett