Do you know of PPT, a little-known technique for “double paying” your mortgage? The secret of this extremely powerful technique is amazingly simple. It’s so obvious that nearly everyone overlooks it. All it takes is minimal effort and a little planning…
I wrote an article in the May/June ’96 edition of Chiropractic Economics, “A Peek at a Practice: A Case Study,” in which I discussed reducing a chiropractor’s overhead. One of my recommendations was to pay off the doctor’s mortgage by using a “double payment method.” The phrase “double payment method” produced a volume of requests for an explanation of this technique.
This little known financial technique is called a Principal Pre-payment Technique (PPT). The PPT technique is a step-by-step guide to saving thousands of dollars on your home or office mortgage. This technique is equally applicable to installment notes and credit card loans, but for the purpose of this article, I will discuss the PPT technique in reference to paying off a mortgage early.
The “secret” of this extremely powerful yet little utilized technique is amazingly simple. It’s so obvious that nearly everyone overlooks it. If you apply the following instructions you will cut nearly 50% off your mortgage interest charges and pay off your loan 12 to 23-1/2 years early rather than in 30 years.
It’s amazing to me how doctors will invest their spare money in savings accounts, bonds or treasury bills to earn a whopping interest rate of 4 to 6%. Why not earn 1,701% interest instead by using the Principal Pre-payment Technique (PPT)?
First, let’s discuss some terms.
Principal is the actual amount you borrow and is also that part of a mortgage payment that reduces the amount of the loan. Interest is the money you pay for the use of the lender’s money. If you place $100 per month in a savings account at 4% interest, you’ll earn $26 interest per year. At the same time, if you had a 30-year $80,000 mortgage at 10% interest, and pre-paid an additional $100 per month on the principal-only portion of your mortgage, you will save $80,797.80 of additional interest, producing earnings of 377.5% interest. Earning interest or saving money is the same. “A penny saved is a penny earned,” as Ben Franklin said. It’s your choice where you want to place your money.
Here are three common pre-conceived notions regarding mortgages and installment notes.
1. You do not have to pay monthly payments for the full number of months stated in your mortgage.
You can pre-pay the principal portion of your mortgage, or pay off your mortgage at any time. (Check to make sure your mortgage does not have any pre-payment penalties).
2. Don’t believe that after making mortgage payments for 15 years on a 30 year mortgage you will have 50% equity in your home.
Not true! After 15 years, a 30-year mortgage for $80,000 at 10% interest will reduce the amount of your loan only $14,669.63. You will have paid $111,701.17 of your payments up to that point for interest charges.
After 20 years, you will have paid the absolutely incredible sum of $168,494.40 in interest charges and only reduced the price of your loan by $26,876.85.
Here’s another interesting fact.
3. Nearly 50% of the amount of your original mortgage amount is paid in the last six years of your loan.
How much then does your $80,000 house or office really cost? Hold on to your hatsit ranges from $80,000 if you pay cash to an unbelievable $252,734.66 when 10% interest is added. The average person will pay 315% of the price of their house by the time it is paid off.
Here’s how the Principal Pre-payment Technique works.
To illustrate the mechanics of the Principal Pre-payment Technique (PPT), an amortization schedule for the first 12 months of a sample loan is illustrated in Table One. By pre-paying a future monthly principal-only payment, you can save paying the corresponding interest charges associated with that payment. This does not mean paying another principal and interest monthly payment, just the principal-only portion of future payments.
When you make the first payment (principal and interest due on 1-1-97) on the amortization schedule, also pre-pay the principal only portion of the payment due on 2-1-97 of $35.69. The interest charge of $666.37 with the $35.69 principal payment is forever removed. Therefore, for an extra payment of $35.69, you saved $666.37 in interest, a savings/earnings of 1,867% interest.
When the next mortgage payment is due, your payment would be for the 3-1-97 payment (principal and interest) because the 2-1-97 has already been paid. Then pre-pay the principal payment for the amount due 4-1-97 of $36.29, saving you an additional $665.77 in interest charges. By prepaying the principal-only portions of installments two and four, amounting to $71.98, you have saved $1,332.14 in interest. Not a bad return on your investment and it’s tax free to boot!
Consider these facts.
Each month that you pre-pay the next month’s principal-only payment you eliminate one month of your mortgage payments.
If you had an $80,000 mortgage at 10% interest payable over 30 years:
- Pre-paying an extra $100 a month to principal-only reduces your payments by $80,797.80 and eliminates 12 years from your mortgage payments.
- If you make your 1-1-97 monthly principal and interest payment of $702.06 and make a second payment of $702.06 (double payment method) to principal-only at the same time, this will save you approximately $11,947.00 in interest payments. You have just earned 1,701% interest on your $702.06.
And you have reduced the length of your mortgage payments by 18 months. If you continue making double payments, $702.06 for principal and interest and an additional $702.06 toward the principal-only payment, you’ll reduce the cost of your building by $143,303.63 and pay off your mortgage 23-1/2 years early.
What about 15 Year Mortgages?
Does a 15 year mortgage rather than a 30 year mortgage accomplish the same thing as pre-paying the principal of a mortgage? No, it does not. I don’t recommend my clients obligate themselves to a fixed program of higher premiums. I advise them to take out 30-year mortgages and then pay them off early using the Principal Pre-payment Technique. By using the “borrow long and pay off short” technique, you have the option to make one, 10 or zero principal-only payments, depending upon your finances at the moment. You can start and stop the plan any time you want.
When Should You Start?
Is it necessary to start your Principal Pre-payment Technique (PPT) at the beginning of a mortgage? No, but the technique is more effective if you do. It is wise to begin wherever you are in the terms of your loan, except, of course, the last six years. Granted, the savings won’t be quite as much as someone who started pre-paying from the beginning of the loan, but they will be substantial.
Nine Rules for the Principal Pre-payment Technique
1. Read your mortgage or loan agreement.
Some say you have to pay the exact amount of a principal-only payment or the lending institution will post your additional payment to the end of the mortgage. You’ll still save money, but not as much. Other lenders place a restriction that prohibits you from pre-paying 25% of your mortgage in one year or else you’ll have to pay a penalty. Few mortgages have this clause and most people will only violate this clause when totally paying off their mortgage.
2. Have your bank give you an amortization schedule for your loan.
Some institutions will charge you $25-50 for this service. Buy the amortization schedule from the bank because you will be sending them a copy of it when you make your payments. You want their amortization schedule to identically match the copy you send them.
3. Do not skip any regular monthly payments of principal and interest.
It is absolutely necessary to make at least one principal and interest payment each month as agreed to by the mortgage document.
4. Send in the proper documentation.
If the lending institution provides a payment booklet or couponsand they usually dobe sure to send in the correct coupon(s) to correspond to the month for which the regular principal and interest payment is being made and for the months the extra principal-only payments are being made.
5. Keep good records.
Make a notation on the coupon/payment booklet clearly itemizing the month of your principal and interest payment and the months of your principal-only payments. Many lenders include a line on your monthly payment bill or coupons for-these extra payments.
6. Each time you send a payment to your lending institution include a copy of their amortization schedule.
Write the date and your check number opposite the monthly principal and interest payment. Write the same information on the front of your check.
7. Next, write a second check for the number of principal-only payments you want to pre-pay.
Mark off the principal-only payments on the amortization schedule and note the check number that is paying off these principal-only payments and the date of your payment.
8. Send a cover letter to your lender with both checks and the corresponding coupons or payment slips.
The letter should read as illustrated in Figure One. Note: By telling the lender to apply your pre-payments to specific numbers on their amortization schedule, they will have to apply your money to these payments rather than to the end of your mortgage payments.
9. Have your CPA write a follow-up letter to your lender.
This should be done after the first of each year to verify the payments you paid to the lender were properly applied and your mortgage balance is correct.
The end result of this Principal Pre-payment Technique is immense savings, quicker home and/or office ownership, enhanced wealth and you control the total cost of your home and its pay-off date.
When is the Principal Pre-payment Technique not a good idea?
1. When you can’t afford it.
Because of changing financial circumstances, you can revert back to the required lower monthly payment.
2. When other rates are higher.
When inflation rates are higher than the interest rate you are paying, or when you can earn 5% more interest in another safe investment, invest elsewhere to get a higher yield.
3. During the last six years of a mortgage note.
The reason: the payments are almost all principal and very little interest.
What about the tax advantages of having a home mortgage?
The benefits of pre-paying the principal of your home always exceeds the benefit of a tax deduction from your home.
Do lenders object to the Principal Pre-payment Technique?
No, as a matter of fact, they like it. Lenders benefit from acceleration of principal payments because it reduces their risk. The higher your equity in a piece of property the less likely they will have to foreclose on it. And, if foreclosure becomes necessary, the higher your equity the more likely they will recoup their investment.
Will the Principal Pre-payment Technique work with an adjustable rate mortgage?
Yes. It works the same as with a fixed rate mortgage except you’ll need to request a new amortization schedule each time the lender changes rates. The rule of “borrowing long and pay off short” also applies to adjustable rate mortgages.
I eagerly await to hear the results of your own application of the Principal Pre-payment Technique to your mortgages. Happy savings to all of you.
Dr. Peter G. Fernandez is a 1961 Logan College graduate and is past president of the Florida Chiropractic Association. He has been a practice consultant for the last 16 years and in this capacity has consulted with approximately 5,000 D.C.’s and in the opening of over 1,500 new practices. Dr. Fernandez can be reached at Fernandez Discipline, 7777 131st St. N., Suite 15, Seminole, FL 33776, or call 1-800-88-CHIRO (l-800-832-4476).