How to use a mortgage calculator
Last week in Moneywise, we covered the basics of math calculations for mortgage principal and interest when reviewing your mortgage payments*. This week, we start the review with:
• Irregular payment intervals. Some banks charge mortgage interest by the day so you need to calculate carefully the number of days in the billing cycle.
• Adjustable interest rate mortgages. The interest rate is not locked in at closing and will fluctuate depending upon capital markets and your bank’s lending policy.
• Setting up a chart (line by line) to monitor your mortgage payments,
• Suggestions to find additional cash to pay off your mortgage faster,
• And lastly, using the same approach to reviewing your credit card payments, if space permits.
Thanks to an anonymous readers (circumstances changed for confidentiality to an illustrative composite case), here is their mortgage payment question. We are regular readers of your column, and after scrimping and saving, bought our first home a year ago. Hooray! I’m 40 — my wife is 35 years old. Originally, we thought we would obtain a 30-year mortgage, but opted instead for 20 years — since I certainly didn’t want to still owe on a mortgage after age 65! We planned on making regular payments against the principal; our lawyer made sure the mortgage contract allowed for prepayment without penalty. We found our first payment mortgage statement incredibly confusing as well as discouraging, given the amount of the payment allocated to just pure interest. We find we are now uncomfortable waiting a month to see the prior month’s payment on the bank’s statement and have decided to verify (on our homemade spreadsheet) the bank’s calculated numbers against ours. Any hints are appreciated.
Facts taken from statement. Let’s run their calculations, using the same numbers as last week.
Mortgage amount: $400,000
Interest rate 6.50 percent (note this is a variable rate)
Term: 20 years
Fixed payment amount, monthly: $2,982.29
Billing cycle: May 21 to June 23, 2013. Property purchased one-month prior.
First assumption: this bank calculates mortgage interest by the day. Our computations last week (refer to the article if you have saved it or pull it up online here) talked about calculating monthly interest. So, we need to know the dollar amount of interest on $400,000 (annually) and then figure out the amount of interest per day — due to the odd number of 33 days.
• Math: $400,000 times .065 — remember to convert 6.50 percent interest rate to decimals.
• Answer = $26,000 annually. Now divide $26,000 by 365 days in the year.
• Answer = $71.23 interest cost per day
• Number of days in the calculation. There are 33 days (not 30 or 31 days, possibly due to a holiday or computer issue interrupting the normal monthly count application)
• 33 days times $71.23 = $2,350.68 interest
• Subtract the interest from the fixed monthly payment.
• $2,982.29 minus $2,350.68 = $631.60 can be applied to the mortgage principal balance.
Question is, why is this principal number not the same as last week’s principal payment? The difference is due to calculating interest daily instead of monthly.
You can also check your numbers using free commercial mortgage calculators online, such as BankRate.com, but remember that their calculations are done on a monthly basis. Bankrate.com allows you to see and print your entire amortisation schedule for the full mortgage term, a good reference for use as years of payments roll by. Bankrate also has a terrific how to video demonstrating how to use a mortgage calculator. Check it out. http://www.bankrate.com/calculators/mortgages/mortgage-calculator.aspx
There is often serious lament about how little cash initially goes to mortgage principal. This is the conventional amortisation method for most financial institutions, used almost universally. Interest is paid first with the remainder of the fixed monthly payment going to principal. However, at around halfway point (ten years) the tide turns; more principal is applied than interest.
How can you reduce that interest cost? By applying every extra dollar that you do not need for the family budget, superfluous spending, retirement and so on, to your mortgage principal.
Now, see the chart example — attached when only $200 a month extra is applied to principal only. You can do this on paper or using a spreadsheet. The remaining balance is recalculated for the reduced interest amount. Over time, as stated in part 1 of this series, the principal reduction accelerates. Had your mortgage for some time? Run your numbers through www.Bankrate.com by using the most recent principal balance — see where you can end up. Become comfortable with trying different amounts and times.
Beware adjustable rate mortgages. Currently, the our mortgage couple’s rate is stable at 6.50 percent, but what will happen if the interest rates go up, to say seven percent? They will have to calculate the interest per day on the higher rate, paying higher interest, with even less applied to principal. If, oh glorious day, the adjustable mortgage rate in Bermuda should drop to six percent or even 5.5 percent (pray for it), then less interest is due, and more of the fixed monthly payment goes right on principal reduction.
Your mortgage may not look exactly like the charts enclosed. Each lending institution will have its own method of reporting. Confused? Write to me. We will decipher it together, confidentially.
Can you find those extra dollars? You have to want to “really” own your home — with no debt — more than anything. It will not be easy, do the best you can, even if you cannot always save the extra every month. Some suggestions where cutting back a little adds up to real savings:
• A two-pack-a-day smoke habit may cost $200-$300 per month. Beer, wine, perhaps half or one-third that amount.
• Snacks and lunch out each working day can top $150-300 per month as well.
• Dinner out twice a month adds up, as do so many of those non-nutrition “fun food” munchie items we all buy but don’t really need for our health or pocketbook.
• Frequent trips to the ATM machine. What did you do with that cash?
• Go for shorter, low-cost vacations.
• Forgo high fashion if you can. Stick to easy-to-wear low cost cleaning bills styles. It’s what you know, not what you show that really counts in career advancement.
Above all, please, please check your statement each month. If you don’t understand what has transpired call your mortgage officer for clarification. Never assume that all information provided to you is correct. Banks are under profit pressure, while operating with cost-efficient staff, but mistakes can be made.
That’s it for this ‘Managing Your Money’ article. Next piece in the series focuses on credit card debt and will be featured on August 9, 2014. Then, we are moving on to an intense detailed look at mutual funds, including what is currently available in Bermuda. Globally, mutual funds are more popular than ever, a powerful indication that the small investor has just about given up on individual securities investing.
*See Royal Gazette for July 12, July 19 for part 1 and part 2 of Managing Your Mortgage and Your Money.
Dear readers, I am planning on providing a series of very low cost Financial Fundamentals — Managing Your Money workshops in early October 2014. If you are interested, please let me know what the most important money topics that concern you today. I am also looking for a sponsor(s) as well that would be kind enough to provide appropriate space. Proceeds will benefit local charities.
Martha Harris Myron CPA CFP Masters of Law: International Tax and Financial Services; appointed to the Professional Tax Advisory Council, American Citizens Abroad, Geneva, Switzerland. President: The Pondstraddler Life™ Consultancy providing international financial planning for the challenging lifestyles of multinational individuals and their families residing, working, crossing borders, and straddling ponds in the North Atlantic Quadrangle. Specific focus for residents of Bermuda, the premier international finance centre. Contact: firstname.lastname@example.org
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