Did you know that your mortgage is a closed end loan? What is a closed end loan, you ask? A closed end loan is a loan that has limitations because the money paid in cannot be withdrawn. Meaning that once the money is received by the lender it is paid on the balance owed and equated into an equity position in your home. Equity is the different between what you owe and how much the property is worth. The lender will apply a full scheduled payment. If you desire to pay toward your principal you must specify that the money needs to be applied to the principal. Oh, by the way, you must be current on your mortgage to be able to pay on your principal balance. Remember, the lender is in the business to make money so if you do not instruct the lender, where to apply the extra payment they will apply the additional money to, you guessed it, interest, because that is how lender makes money. Interest, of course, is the rent that you are paying the lender to borrow their money to get your home.
The closed end loan is driven by an amortization schedule. This amortization schedule does not move at the speed of light. It moves the opposite slower than a snail. Hence, taking 30 years to pay it down. Before we go any further, I feel you need to understand what an amortization schedule is. It is the blending of loan payments showing the principal and the amount of interest that you are paying each time you made your scheduled payment. Why, you ask? Let examine. If your mortgage payment was $2,000.00 a month. You will pay only $199.10 to principal and a whopping $1,800.90 to interest in your first month. The second month, the amount to principal will increase by only one additional dollar, so for every month that follows there is only one more dollar applied to the previous months principal payment. That’s right one dollar. For instance, month two the principal payment is 200.10, month 3 $201.10, month 4 202.10, etc.
Another interesting thing about a closed end loan is the interest charges are from the principal balance at the end of the month. In other words, the interest paid is for the next month not the month that the bill is due. The interest is a pre-determine amount. Meaning it is calculated daily but applied to the month end principal balance. Now, this does not effect daily interest in the month the payment is receive, but effect the following month pre-determine amount.
It is should be easy to see that in order to reduce the choke hold that the lender has on us through our mortgage we must reduce our principal balance.
Stay tuned to our next broadcast to find out how…..