Comments on: If You’re Going to Pay Extra on a Loan, Do it Sooner Rather Than Later

By: JLP

JLP — Tue, 22 Jul 2008 17:27:07 +0000

lex said:

“I thought you understood the concept of time-value-money.”

I understand it, but I thought AFM readers would enjoy the illustration.

I appreciate your very thoughtful comment, though.

By: lex

lex — Tue, 22 Jul 2008 17:00:53 +0000

I thought you understood the concept of time-value-money.

By: Steve

Steve — Sun, 20 Jul 2008 08:03:03 +0000

@Kevin,

Car loans are typically daily interest loans, whereas mortgages are fully amortized interest loans. When you pay extra on a mortgage payment, it doesn’t change the amount of interest owed because the interest is pre-calculated on a fully amortized schedule. Car loans accrue interest daily, so the date that you pay the loan resets the interest owed to zero on that day. This is why I pay my car loan in two payments; the full payment on my first check, and an additional payment on my second check. By doing this, you are lowering the interest owed by resetting the interest to zero with each check, rather than applying the whole payment to the principal.

Home equity loans and HELOCs are done the same way. Do a google search on the difference between a fully amortized loan and a daily interest loan.

By: George

George — Sat, 19 Jul 2008 21:42:13 +0000

congratulations! you just learned the lesson of compound interest! You are earning (or in this case paying) the same rate on your money regardless of when you pay the amount – your loan interest rate is 7.4%. You pay this on the outstanding balance every month. The lower the balance, the lower the interest payment. But your return is always the same – 7.4%. If you can earn more on your investments than 7.4% (pretty hard to do right now) than don’t pay it off early. If not, than pay extra and get the loan off your back and earn 7.4%. Irreregardless (Dave – don’t sic the grammer police on me), the interest rate is the determining factor.

By: hoosier

hoosier — Sat, 19 Jul 2008 20:00:03 +0000

as long as the interest you get on a savings account is only 3-3.3% at best and your car loan and mortgage are at interests above 5.75% it makes sense to pay these loans sooner if you have the extra cash and have enough in savings to get you over a rough financial patch ( your financial cushion).

we have always payed our high interest car loans 1-2 years earlier because of lower return we get from our savings account. I kept up to the term only a 3 year 1.9%APR loan we got 5 years ago on a VW car as the interest of our savings account was then above 5%.

if you invest in stock it may be better or it may be worse, you never know for sure. and I tend to invest in equities only for long term ( IRA and the such) as these are money I will not be spending ( bar a dire emergency) for another 25-30 years.

By: JLP

JLP — Sat, 19 Jul 2008 14:43:55 +0000

Dave,

You got me. I know that and yet I still messed it up. I’ll fix.

By: "Mo" Money

"Mo" Money — Sat, 19 Jul 2008 14:32:59 +0000

This happens with a mortgage also. If you have a 15 year mortgage, you home is paid for after 15 years, but if you take out a 30 year mortgage after 15 years you will still owe about 66% of the original mortgage. In other words you have only paid off 1/3 of the principal.

By: Eden

Eden — Sat, 19 Jul 2008 14:06:16 +0000

Yep, this is something I thought about recently too. I’m only a few years into my mortgage, but I’m not in any position to pay extra yet as I still have credit cards and some student loan debt to eliminate. By the time those are done, I’ll have missed a lot of the great money saving opportunities on early mortgage payments.

By: Dave

Dave — Sat, 19 Jul 2008 13:24:31 +0000

I suppose I’m being picky, JLP, but as a matter of principle, someone in the financial services business should know the difference between the words “principle” and “principal.”

By: Kevin

Kevin — Sat, 19 Jul 2008 08:29:19 +0000

What I hate about my car loan is that I see the interest go up and down depending on when they receive my payment. One month my interest could be $50 and the next could be $55. It is unlike my mortgage and HELOC where the interest payment always goes down. It must be because my car is a retail loan that the interest. Seeing this interest go up after I paid money towards the loan makes me hate the bank and just want to pay it off even sooner. The loan started off on the wrong foot when they were sneaking in monthly charges for “insurance” or something similar. At least I have a decent rate of 5.35%