Help understanding interest rates impact on loan....

[c3troop]

So I know everyone says pay off the higher interest rate first. I have a student loan for 6000 with a 6.5% rate. Over the life Of the loan it will be 2000 interest. But if I put that 6000 to my mortgage at 3.875% it will immediately knock off a few thousand dollars of interest off the loan. So why would I pay the higher interest rate off when I could save more paying towards the house? This confuses me greatly. Can someone explain where it is that I'm missing something?

[disneysteve]

if I put that 6000 to my mortgage at 3.875% it will immediately knock off a few thousand dollars of interest off the loan.

No it won't. It will only knock off the 3.875% interest that would have been paid on that $6,000, just the same as sending it to the student loan will knock off the 6.5% interest that would have been paid. It doesn't matter how large the loan is. In either case, what you save is the interest on the amount you prepay.

[c3troop]

Ok so I have been going about this wrong. I was told if you if you look at the amortization schedule you could tel how much you would save in interest by looking at what your principal dropped to. For instance 300 goes interest and 800 goes principal. I pay 1600 extra to principal I would save two months if 300 dollars interest thus 600. So this is incorrect?

[disneysteve]

Ok so I have been going about this wrong. I was told if you if you look at the amortization schedule you could tel how much you would save in interest by looking at what your principal dropped to. For instance 300 goes interest and 800 goes principal. I pay 1600 extra to principal I would save two months if 300 dollars interest thus 600. So this is incorrect?

Yes, that is incorrect. Interest is charged on the outstanding balance. Let's say your initial loan is $100,000 at 5%. Your first payment is 30 days of interest at an annual rate of 5% on $100,000. That would be about $411 interest that first month.

Let's now say that along with your regular scheduled payment, you also send in an extra $5,000 toward principal. So for month 2, your interest will now be calculated on an outstanding balance of just under $95,000 (since a little of the first payment went to principal also). So for month 2, you'll pay about $390 in interest. You will have saved about $21 by prepaying the $5,000 towards principal. Of course, that is $21/month for the life of the loan. On a 30-year loan, that's a total savings of $7,500.

[greenskeeper]

Ok so I have been going about this wrong. I was told if you if you look at the amortization schedule you could tel how much you would save in interest by looking at what your principal dropped to. For instance 300 goes interest and 800 goes principal. I pay 1600 extra to principal I would save two months if 300 dollars interest thus 600. So this is incorrect?

If I knew your loan value I could give you a more precise answer, but as an example.

If you have a 30yr 3.875% loan of $100000:

total interest after 30yrs : $69,285.35

total interest w/ $6k extra principal applied : $57,318.22

So that $6k turns in to $11,967.13 of "savings in interest", and the loan is paid off about 3yrs earlier.

Of course this example is if you applied the $6k at the start of the loan, if you are already into the loan the savings will be less.

A great calculator to play with is http://www.bankrate.com/calculators/...alculator.aspx

What I would do is pay off the student loan, then with the student loan payment that is eliminated put it towards the principal of your mortgage, since you are already have that payment in your budget. Then your mortgage will shrink!

[c3troop]

Ok so here it is

15 year mortgage re-finance started January 2011 a 98,600 now down to 94,000 due to additional money put into it.

One of the student loans is roughly 6,000 at 6.8% for I think 10 years.

If my math is right, if I pay off the loan, I will save about $2,000 in interest. But if I pay that $6,000 into the mortgage, I will save more than $2,000 in interest. Is that right or wrong?

And if that is correct, why would you pay off the loan instead of hammering on the mortage where you could save tens of thousands of dollars by paying off early?

[greenskeeper]

the general rule is to pay the high-interest loans first to get debt free, generally applies to credit cards, auto loans. Most people look at a mortgage as being last in line to pay off.

I already gave you advice on what I would do. You save more in interest on the mortgage because it is a bigger balance and a longer term.

Did you use the calculator link?

[c3troop]

Yes and I have used it before which is why I always thought it was smarter to pay off the house given the large amount of interest you save.

[greenskeeper]

If you have an adequate emergency fund, I would pay off the student loan.

Then as I mentioned apply the student loan payment towards your mortgage principal each month. You already have that expense in your budget, why not put it towards paying down the mortgage?

On the flip side, it also makes sense to drop the $6k on the mortgage and continue to pay the student loan as you have been, just now what I personally would do.

If a mortgage and student loans are your only debts, i'd say your in good shape no matter what you decide!

[jpg7n16]

If my math is right, if I pay off the loan, I will save about $2,000 in interest. But if I pay that $6,000 into the mortgage, I will save more than $2,000 in interest. Is that right or wrong?

That is correct, but misleading.

You are comparing very different timeframes. If you pay off the student loan, you will save $2000ish in X years.

If you would like to compare this against paying down your mortgage, you should calculate the interest you will save on your mortgage in the same X years, not the entire length of the mortgage.


That's like saying that someone who is in a contract to earn $10,000 for the next 15 years will make $150,000 and therefore make more than someone under contract to earn $100,000 this year. That's just a poor comparison.


To save you a lot of time and mathematical headache, the easy answer is to just say, what rate of interest am I saving? 6.8% > 3.875% and will therefore save more money by paying down the 6.8% loan first.

[naomibatac]

@JPG, that was fast and easy computation. Actually, anywhere I read, the usual advice is to pay first the credits with high interests, especially if the amount is huge.

[YLTL_Dan]

Knock out the student loan - you will feel a lot better crossing it off your list. If you're serious about paying down your debt, the small difference in additional savings by paying towards the mortgage will be offset by the satisfaction of paying off the student loan. Either way, great work!