Question:

I have mortgage prepayment plans – what is the best strategy?

Answer:

For consumers with mortgage loan prepayment plans, there is a common dilemma: Should I take out a bigger loan and pay off a large sum immediately, or take out a smaller home loan amount?

This is a common question. Should you take out a $250,000 loan and pay off $20,000 immediately, or simply take out $230,000?

If you take the larger amount and prepay a huge part of it upon signing the mortgage agreement, you will have a smaller principal and larger mortgage payments which will help amortize your loan faster. Look at the table below to see how mortgage amortization and different prepayment planning might work for you:

$250,000 at 6.5 for 30 years with $20,000 immediate payment $230,000 at 6.5% for 30 years
with standard amortization with mortgage biweekly payment plan with monthly prepayments of 1/12 of the normal monthly mortgage payment
Monthly payment of principal and interest $1,580.17 $1,453.76 $ 726.88 every two weeks $1,453.76 + $121.15
= $1574.91
Mortgage term 24 years 30 years 24 years 2 months 26 years 8 months
Interest cost savings over the life of the loan $94,036.05
(Subtract $20,000 here to get a more realistic picture of IC savings.)
0 $ 67,560.03 $31,499.11

According to the comparison table a home loan biweekly prepayment plan is doing almost as good as the strategy of taking a larger loan and paying off some principal immediately. Also, taking a larger loan creates larger settlement costs to be paid upon closing, so any advantage this larger loan amount scheme may have is gone, compared to a simple bi-weekly prepayment plan.

Also, the above calculated numbers will vary for consumers have to pay taxes and insurance, which have been omitted deliberately from the above calculations.

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