I think today is a good time to talk about my mortgage and how I see it. This is clearly a liability for me, but a liability that I am comfortable to keep in it’s current form in order to sustain my lifestyle. In this post you will be able to see my view related to mortgage prepayment benefits.
We bought a house slightly different than the one in the image via a down payment and a mortgage of 255,000 EUR in local currency. The condition for the mortgage is based on a fixed interest rate in the first years and a variable one afterwards (from month 61) until the end of the 30 years term.
After doing some math via Dr Calculator (to be fair, I had the app and abused it during flights as it also works offline and can email you the summary) the total payment for this loan would be 530,000 on a 255,000 principal. To me this is insane and we decided to pay as much as possible in the first 5 years of the loan. We do this in order to protect ourselves in case the variable interest will remain at it’s current 6.2% calculation. If this drops, then we are in a good position, but as no one could predict it for certain, it is best to be safe than sorry. For those interested, you can check this mortgage study.
As we do not want to stop investing, we decided to put some money here and there until we reach either a more comfortable position, or until we take a different direction. For example: if the stock prices are low, we buy, if they are high, we pay in advance on our mortgage; if the EURO is high then we convert it to local currency and pay in advance to our mortgage, if the EURO is low, we just keep our savings in EURO.
The first decision we took was to reduce the monthly payment of the loan. I know that this is not the optimum option and that it is more profitable to reduce the duration of the loan via an early payment, but that was our decision. As we aim to pay in advance we acknowledged that although it may not be as good as reducing the duration, but as long as we can continue paying in advance once or twice a year, we should be somewhat in the same region with the savings on interest for our mortgage. In order to illustrate the two, I have added below 2 comparisons done via Dr Calculator.
Option 1: 10,000 EUR paid early in order to reduce the monthly payment (what we did). Calculated savings of 10,700 EUR
Option 2: 10,000 EUR paid early in order to reduce the loan duration (mathematically optimal option to reduce the interest paid). Calculated savings of 14,000 EUR
Please keep in mind that if the fixed rate would be for the whole duration, the above calculation would show a higher saving. Because we have a different interest rate starting from month 61, the whole loan is recalculated from that month onward as a new 25 year loan for the principal left over at a variable interest.
Now I am showing you the same 2 examples without a change in interest during month X of the loan. Please note that in this case, the total payment is less due to a lowered interest rate throughout the 30 year period.
Option 1: Calculated savings of 7,500 EUR (Worst than before due to the fact of less principal being paid from month 61 – although it sounds fishy, the math is correct)
Option 2: Calculated savings of 23,200 EUR (Yes, the spike is this big between the two)
It may be a lot to sink in for now, but I would recommend that you start playing with some calculators and do your own simulations. Even if you are not looking at a mortgage, look at your credit card, student loans, overdraft, etc.
Now, it is time to come back and talk about my mortgage. We did the 10,000 payment and after a few months, we cam into 20,000 (past down inheritance) that we decided to further put on the mortgage. Again, we decided to reduce the monthly payment instead of the loan duration (we just want to make sure that we can pay it in case of an income setback as I do not have a steady line of work). Savings are totaling now 31,500 EURO.
It is starting to look better and better, especially considering that originally we had to pay 275,500 in interest and now we managed to reduce it to 239,000. So far by reducing the monthly payment we have a rough 1:1 ratio for interest reduction vs prepayments made.
To be fair, the decision to reduce the monthly payments was mainly due to our income than and the uncertainty of my job. After having a period with no income, I managed to sign another short term contract and now we decided to further put down some money and reduce the loan term.
Prior to proceeding with our 3rd prepayment, we calculated what we still had to pay and something was fishy: we now had to pay 219,000 although we paid 30,000 in advance and 4,500 in principal via monthly payments. There was a 1,500 EUR gap. Doing some more math, I realized that the difference is due to the currency exchange between the two. Our local currency depreciated vs the EURO currency rate we negotiated when we bought the house and took the mortgage and this helped us repay it faster.
After this was sorted out, we moved forward with a 10,000 payment aimed to reduce the duration of the loan. As the calculator cannot do both reduce monthly payment and reduce loan duration I am showing some math, but it is not the 100% accurate math.
Option 1: All prepayments aimed to reduce monthly payment. Total savings of 41,900 EUR, this keeping the 1:1 ratio
Option 2: All prepayments aimed to reduce the loan duration. Total savings of 53,500 EUR
Closest math I could do by using previous calculation for the 30,000 total paid in advance and doing a new calculation starting from month 12 for 29 years and interest increase from year 4. This results in a total saving of 44,300 EUR (31,500 + 12,800)
As you can see this falls somewhere between the 2 options presented before as it actually is a combination of both.
My conclusion on mortgage (or loan) prepayment
It is now time to conclude this post and share my feedback on mortgage prepayment benefits. This is my sincere recommendation and you can the summarized conclusion below:
- Always do the math and decide if you want to prepay on your loan or invest that amount
- Always do the math and decide if you want to reduce the monthly payment or the loan duration
- If you get paid in a different currency than the loan is issued, try to find a way that is in your advantage rather than the bank. Consider inflation, currency fluctuations or even the stability or instability of your local currency (a good example is USD vs TRY for 2018)
- Everything is negotiable when you are talking about something that costs more than 1,000 EUR (personal observation). Always try to negotiate prior to accepting whatever price and rate is shown to you.
Any of these findings should be assessed by you based on your personal situation. The decision on how to move forward is your personal one. You can either copy what I do or what others do, or make your own strategy in order to achieve your benefits by prepaying on the mortgage. I wish you the best and hope we get rid of our mortgages soon. Happy to see your comments and your progress in the comments below.