How To Make Three Thousand Dollars Per Hour

People generally are bad at math, but they are exceptionally bad at math when calculations involve time, interest, and money.

When my wife and I purchased our house in August of 2006, we asked our banker about bimonthly payments. I had heard that setting up bimonthly payments would pay off your mortgage seven years early or something like that. She told me that she that is a common misconception that people have when buying a house. She explained that when you set up bimonthly payments, you don’t actually pay off your house early because you’re paying less interest, you are actually making one extra payment every year. Thirteen payments is larger than twelve payments so it makes sense you would pay off the house earlier.

Today I was on the phone with a representative from the Bank Of North Dakota because I had some questions about when our next mortgage payment is due because my wife accidentally made our payment much earlier than usual. I am the paranoid type and I think that everyone is trying to screw me all of the time so I wanted to call to get clarification on when our next payment is due. After getting the answer I was looking for, I inquired about how I could set up bimonthly payments with the bank. Again, this banker explained to me that some people think that if you make a payment in the middle of the month, then during the second half of the month you’re not paying interest on the money you paid off during the first part of the month. This is a myth. Long story short, you pay interest on the full amount for the entire month. I told the banker that I understood that, but i still wanted to reap the benefit of paying bimonthly because I will still pay off my mortgage early because there are twenty partial payments each year which means that I will be making one extra payment each year. He acknowledged that he understood my point of view, but there was no way for them to accommodate two principle only payments each year automatically. He suggested some manual work around which didn’t interest me. Automation is where it is at.

I hung up the phone and started to deliberate my situation. My next payment wasn’t due until Feb 1st. I will get paid at least three times before then, so would it be better for me to save the money to boost my emergency fund, or should I make a principle only payment I wondered.

I stared at my mortgage payment transaction history. While examining each line of the statement, it occurred to me that this was a principle only payment so they entire amount would go toward the principle. That is why they call it a principle only payment. Ok, that is cool i thought, so how many ‘regular’ payments would this be equivalent to? That is when my mind was blown away.

When you’re in the beginning of a mortgage or other amortized loan, the majority of your payment goes to interest. As time goes by, you start to pay more of the principle with each payment. Each month, we pay a couple of dollars less in interest and the principle portion of the payment goes up. In addition to principle and interest, your mortgage payment also has taxes, specials, home owners insurance, and mortgage insurance.

After everything is said and done, I figure in the neighborhood of 10% of our payment goes toward the actual principle. In my case making one extra payment is the equivalent of roughly ten regular payments. What? Can that be right? Making one principle only payment right now will reduce the amount that i owe on my mortgage by an amount that I am not scheduled to get to on the amortization schedule for ten months. In other words, this one principle only payment will reduce the duration of my mortgage by almost one year.

If I would have started doing this when i first bought my house three years ago, then in the amortization schedule, I would be at roughly the middle of March of 2014. I would have hacked off four years of my mortgage and almost ten thousand dollars.

Lets say that it takes me five minutes each month to make a mortgage payment online. In a year that is one hour’s worth of work. Over the last three years, that works out to be about three thousand dollars an hour.

To be fair, it is not quite as simple as that. If I would have made bimonthly payments, then I would have had less money for other things. I understand that. Some of this money was used to pay for investments and paying down credit card debt. On the other hand, knowing myself, I am sure that i spent a good chunk of the money on something foolish like beer, chicken wings, and dog daycare.

The second thing to notice is that the number of payments that one principle only payment is worth will decrease with the life of the loan. Towards the end of the loan, one principle only payment will be worth only two or three regular payments so it slows down drastically.

There are some other considerations for this discussion as well. First, we are paying mortgage insurance each month until we get 20% of our loan paid off. That isn’t scheduled to happen until about 12.5 years into the loan. On a bimonthly schedule, I would estimate that we would have it paid off in about one half that time.

December 21, 2009 Posted in: money