I don't really understand financing, and so I have a question about a real estate loan. I have a loan on a piece of property that the seller financed, so there's no mortgage company involved. I have an amortization report here that tells me that for payment number X there is a certain amount for interest, a certain amount for principal, and the total remaining balance. If I make extra principal payments, how does that affect the report? Do we just drop down to the payment number that matches the remaining balance and continue from there, or do I have to get a new amortization report each time? If the former is correct and we just move up to the matching payment number, how best should that be documented? Gracias, feel free to PM me if you need more detail. Additionally, a recommendation for a finance primer would be appreciated.

Tillman, as a general rule in Texas, all prepayments have to be applied toward principle. If you make additional payments, but keep the monthly amortization the same, the result is a shorter term. I have a amortization program that I wrote a long time ago in Lotus that I can send you if you like. If you play around with this, you'll probably figure out everything you need to know. Take care, Dale

Very good question Tillman...was wondering this for awhile now as well. Wife and I always pay additional towards the principal every month, and often wondered how this would affect the payoff term vs. the original term at this rate. Basically, I'd like to reduce the 15 year fixed down to say 10 years or less, and would like to "play with the numbers" to see what would be the best scenario. Any help would be greatly appreciated, as I'm not much of a finance person either.

I have an Excel spreadsheet I use for this kind of stuff. If you want it PM me and I will email it to you.

If you get a copy of Quicken or MS Money, you can set up amoritization tables for various loans. You can play with payment options to see what the result is. In your case, making an extra paymnet towards principal will reduce your term. The amount of the term reduction will depend on the particulars of a loan.

A level payment fully amortizing loan is structured so that each payment has an interest component and a principal component. Over the life of the loan, the interest component gradually decreases as the principal amount is paid off and the amount of the level payment that is applied to principal increases. The reason that the interest component decreases (in dollar amount) is because, each month, there is a slightly lower principal balance to charge interest on. Therefore, increasing the payment to repay additional principal will accelerate that effect by reducing the amount of interest paid in dollars on the lower principal amount and, because the monthly payment stays the same, the amount applied to principal increases. This will shorten the loan life and will reduce the total dollar amount of interest paid during the term of the loan. The amount that the loan life is shortened will vary depending on how much you prepay at any one time and how often you make the prepayments. Let's suppose that you have a loan for $100,000 with an interest rate of 5% and a term of 30 years. Using a mortgage table, a financial calculator or a spreadsheet program, the monthly level payment on that loan will be $536.82. For the first month, the interest component will be $100,000 X 0.05/12 = $416.67 and the remainder applied to principal will be $536.82 - $416.67 = $120.15. For the second month, your interest component is based on the new principal balance of $100,000 - $120.15 = $99,879.85; and would be very slightly less at $416.17. Your principal component creeps up to $120.65. This gradual shifting keeps happening throughout the term of the loan until your final payment is almost all principal. Now, if you were to set up the same loan, but on a 15 year amortization schedule, your monthly payment would be $790.79. That extra $253.97 per month reduces the principal that much faster. If you were to increase your monthly payment on the 30 year loan by that amount each month, you would find that the loan is fully repaid after 15 years. So, for example, if you were to make that higher payment on your 30 year loan in the first month, the payment would be applied $416.67 to interest, $120.15 to scheduled principal reduction and $253.97 to additional principal reduction. Now for the 2nd month, your interest component will be based on the new, lower principal amount, which is $100,000 - $120.15 - $253.97 = $99,625.88. So the interest component on the 2nd month's payment now is $99,625.88 X 0.05/12 = $415.11. You have saved $1.06 in interest that month, which is the interest on the $253.97 in additional principal that you paid. I hope that this isn't too confusing. It actually isn't really complicated and is repetitively mechanical over the 360 months of a 30 year loan. It is easier to see using a simple spreadsheet with separate columns for the interest, principal, total payment and loan balance amounts. Of course, if you really want a 15 year loan and can make the payments, you could get a lower interest rate by getting the 15 year term in the first place. However then you wouldn't have the option of scaling back your payment to the lower, 30 year level, if you get in a cash crunch one month. John

That was very informative and helpful, John...thanks for taking the time to share it...much appreciated! So, basically, I simply need to shorten the term of the spreadsheet to find out what the "extra" payment increase will be. In other words, we pay an additional $200 / month or more towards the principal on our current monthly payment for a 15 year fixed loan at 5% would shorten the life of the term by approx. 5 years (?) depending upon the total loan amount. Probably will stay put in our current residence until the kids are grown and gone to college, etc. for at least another 10 years...but then one never really knows. Then, it gets me to thinking that perhaps one should leave the mortgage alone, and invest the $200 / month or more in some other area to yield a better $$ vs. an early mortgage payoff. Decisions, decisions...perhaps I need to sit down for a good chat with our bookeeper

For a decent primer on mortgages, including loan calculators, go to http://loan.yahoo.com/m/ under the Yahoo! Finance section. John

Mortgage interest is tax deductible (at least on loans less than $1 million!) and therefore can be a very low cost source of capital. If you are in a 40% (state and federal) tax bracket, a 5% mortgage costs you 3% after tax. From a purely financial perspective, if you are pretty sure that you can earn more than 3% after tax in an investment (particularly with the lower long term capital gains rate), it makes sense to put the extra money into the investment rather than in prepaying your mortgage. Using other people's money costing you 3% to make a higher return is a pretty good way to increase your net worth, as long as you don't go overboard in taking on too much investment risk or in increasing your chance of defaulting on the loan. Of course, some other factors should enter into the picture, including your tax position, attitude toward investment risk, desire to be out of debt, confidence in being able to continue to make mortgage payments, being mortgage free by time to retire or make college tuition payments, etc. etc. that will help you decide what you want to do. John

Yes, a big thanks here as well to John and others! Guess it's time to sit down, think long term goals, and decide what avenues to take. Perhaps paying off the mortgage much earlier will allow greater flexibility in 10 years for things like helping the kids with college, investing more for retirement, etc.