Pay-Off Mortgage Early.. Does this raise effective interest rate?

When comparing mortgage rates, there are typically two interest rates. An interest rate(A) on the 30yr mortgage and an APR that includes the origination fees from the bank (B).

If you are only talking interest rate A, then you do not change that by paying early.
If you are talking B, then you will increase your effective interest rate as the origination fees will be spread over only 3 years instead of 30.

TiteArse said: I'm not sure how to calculate this so I want some opinions...

Let's say I have a 30 year mortgage at 6%. Lets say I pay the loan off in 3 years instead of 30, have I effectively raised my interest rate BECAUSE during those first 3 years each regular mortgage payment is mostly interest, and not principle?

Thanks!

Rate is the same - you have paid less interest though. However, the origination expenses are a larger share of the the monies paid out to service your loan (interest + orig fees). Interest is calculated on the outstanding balance. Every time you pre-pay, the next payment will result in smaller amount of interest.

when you send in more than a minimum amount, note on the bottom of
the check (or a seperate check) that you wish to apply the extra money
towards the principal. if not, some banks will simply apply the extra
towards the next months payment. this is especially true of auto loan
companies...

didYOUsearch said: TiteArse said: I'm not sure how to calculate this so I want some opinions...

Let's say I have a 30 year mortgage at 6%. Lets say I pay the loan off in 3 years instead of 30, have I effectively raised my interest rate BECAUSE during those first 3 years each regular mortgage payment is mostly interest, and not principle?

Thanks!

I think I see how OP is looking at it -like this (rough #s):

1. My loan was 155k
2. closing costs were 5k
3. in 3 years I made 36 payments of $1000 each
4. I only paid my $155k loan down to $145k.

So Essentially I paid $41k for $10k (5k closing costs plus $36k payments).

Many ppl see their mortgage this way. Of course, while you indeed may have paid $41k and only seen a $10k principal reduction, such a calculation is not accurate and leaves out many factors

Think OP is talking about paying the loan off in 3 years, not only regular payment according to a 30 yr amortization schedule.

During the first 3 years of a 30 yr mortgage, if you stick to the scheduled payments, yes it's mostly interest and not much principal payments.But whatever you pay above and beyond the required monthly payment for your loan gets applied to your principal dollar for dollar. You're not prepaying interest in this case. In DYS example, if your monthly payments are $1000k from the 30 yr mortgage but instead you send them a check for $5000, yoy're effectively paying $4000 in principal and then whatever small portion of principal you'd pay normally as part of your monthly payment on the remaining $1000 (say $100). Total, you'd be paying $900 of interest and $4100 of principal.

The only thing that impacts your effective interest rate is the origination fees. Because those are paid once at the start of the loan. If you sort of spread it over 30 years, it gives exactly the APY quoted in the truth in lending disclosure. If you pay off the loan early, effectively that bumps your loan APY some. The larger the fees and the sooner you repay the loan, the more of an impact it'll have obviously.

Now if the real question is about comparing several mortgages, it's true that lower fees will matter more to you than actual rate if you intend to pay off the loan fast. Instead of rate comparison, you might want to focus on total amount of fees+interest paid in various loan scenario. That's really the bottom line. But then again, if you intend to pay off the loan so quickly, you may be better off with a ARM 3/1, 5/1 or whatever your paying off horizon is instead of a 30-yr mortgage. Rates should be better in general for short loan situations.

I would look at this differently. The fixed costs of a mortgage are the closing costs. The variable cost is the interest rate as it is paid monthly. If the mortgage is in force today and the fixed (closing) costs have been paid, it has become a sunk cost meaning it's unrecoverable and must not be taken into consideration for future decisions. Any new options need to be looked at in comparison to the interest rate that is being paid today.

But to answer the OP's question: YES, if a mortgage is paid off early the effective interest rises dramatically due to the fixed (closing) costs paid up front.

A comparison is a balance transfer to a credit card with 0% interest but a 75$ transfer fee. If the balance is paid off a day after the loan, figure that you paid $75 for the privilege of having say $10,000 for a day. I leave the APR calculations to someone with more enthusiasm.