If you’re not yet familiar with how a loan amortization schedule works, check out Part I: Using a Loan Amortization Schedule first. Then come back here and learn a little bit more about ways you’ll be using the loan amortization in your financial plan.
We discussed that in addition to simply calculate the total cost of your debt payments during the life of the loan, amortization schedules are necessary for determining other financial planning elements including:
- Calculating your net worth
- Projecting your mortgage interest deduction for taxes
- Monitoring your account payments
- Analyzing pre-payments on your loan
- Making refinancing decisions.
We’re going to go through each of these in detail, including exactly how to find or calculate the information that you need for each of these purposes.
DETERMINE YOUR CURRENT/FUTURE NET WORTH
Determining your current net worth requires you to make an inventory of all of the assets that you own and offset them with all of your debts. It is fairly simple to look at your loan statement and get your current balance to include on your net worth statement.
In your mortgage loan example from Part I, we would simply look at our most current mortgage statement and identify the “unpaid principal balance.”
However, in order to project what your net worth will be in the future, say a year from now, you need to determine your loan balances at that future point in time.
Continuing our example from Part I, let’s assume that we want to project our net worth on December 31, 2017. We would go to our mortgage loan amortization schedule and find the ending balance after the December 1st payment (this assumes that the January 1st payment is not made until January 1st). We can see that there is a $175,813 loan balance on this date.
ESTIMATE YOUR INTEREST DEDUCTIONS
I realize that not everyone loves to project their taxes several times a year like I do, but it can be essential if you find yourself needing to make quarterly estimates or analyze the impact of an upcoming taxable transaction.
To determine the student loan or mortgage interest deduction for the year, simply add up the interest amounts for all of the payments made during the year. Assuming that you are someone that pays your mortgage exactly on the 1st of the month, you’ll total up the interest column for all the January through December payments.
In our example, the total mortgage interest to be paid during 2017 is $8,904.
ENSURE ALL PAYMENTS ARE PROPERLY CREDITED
This one is fairly straightforward but essential. By creating your own amortization schedule in parallel with the bank, you’ll be able to spot any differences in the way payments are credited.
This way if you make an extra principal payment and it doesn’t get applied toward the loan balance, you can immediately contact the bank and solve the problem. This likely won’t be a problem as long as you follow your bank’s instructions on how to make extra principal payments.
In addition, keeping your own schedule will make sure you have your own records updated as well. During the years we were living abroad, I set up online bill pay for our mortgage and wasn’t aware when our mortgage company decreased our payment due to an escrow analysis. I ended up paying an additional $80-90 for a couple months that they applied to our principal balance. When I went to compare my loan balance per my schedule to the statement, I discovered the discrepancy and updated my own schedule to reflect the extra principal payments. We also made several sizable extra principal payments that I wanted to ensure were credited properly.
In the example, we can see that the ending balance after the April payment matches the statement.
Do you know the saying, “trust and verify”? That applies here. Most likely, the bank is recording everything correctly, but sometimes mistakes happen. That could be a mistake on your end in not marking the principal payments as such.
ANALYZE THE RESULTS OF EARLY PRINCIPAL PAYMENTS
A key element of loan amortization schedules is that the faster you reduce the principal through making additional payments, the lower all subsequent interest payments will be. In addition, you’ll pay off the loan a lot faster.
Let’s assume in this previous example that this person commits to paying an additional $200 per month toward their mortgage loan starting with the next payment (May 2017).
To calculate the effect of the extra payments, enter $200 per month in the “Extra Payment” column until the “Ending Balance” equals zero, In this case, that would be November 2034. You will have to adjust the last month extra payment to match the amount that is still necessary to pay off the remaining balance.
Here I’m showing only the last few payments as well as the summary of the loan:
With these extra payments, the total interest would decrease from $185,596 to $149,526 over the life of the loan. This is a savings of $36,070! In addition, it will cut the loan terms down to 286 months instead of 360. That’s more than 6 years!
Analyze the results of making extra payments on your own loan. The higher interest rate you have, the more impact those extra payments will make.
ANALYZE THE BENEFITS OF REFINANCING
The decision to refinance your mortgage or other loan involves a lot of different factors. Just one of those factors is the total interest you’ll pay over the life of the loan.
I’ve recently been analyzing whether to refinance my 30-year mortgage to a 15-year mortgage. Going back to our example, we can easily take a look at the impact on the monthly payment and overall interest of the loan assuming that we refinance from a 30-year to a 15-year mortgage. It takes 30-45 days to close on the loan, so we’ll assume that by the time this person researches mortgage companies and provides all the documentation, they will end up closing at the beginning of July.
Let’s assume the following about the potential 15-year mortgage loan:
- Loan Amount: $177,830.27 (balance as of 7/1/2017)
- Start Date of New Loan: 7/1/2017
- Interest Rate: 3.50%
- Loan Terms: 15 years (180 months)
Assuming no extra payments are made on this new mortgage, the new monthly payment will be $1,271.28 compared to the previous monthly payment of $1,073.64.
Refinancing at a lower interest rate comes at a huge benefit though. Starting from July 1st, 2017 through the end of the original loan term (assuming no additional extra payment), the original mortgage would result in $124,695 in interest payments. The 15-year refinanced mortgage would result in only $51,000 in total interest, saving $73,695 over the life of the loan.
Original mortgage interest from refinancing date to end = $124,695
Less: New mortgage interest from refinancing date to end = $51,000
Equals: Interest savings over the life of the loan = $73,695
The best comparison, though, would be to look at the impact of making the same monthly payment between each loan starting on July 1st. This would mean making a $1,271.28 payment ($197.64 extra payments by calculating $1,271.28 – 1,073.64) on the original 30-year mortgage or the regular payment of $1,271.28 on the refinanced 15-year mortgage.
The original 30-year mortgage with the extra payments would result in interest from July 1st, 2017 through the end of the loan of $89,755. The refinanced 15-year mortgage would result in total interest of $51,000. This is a savings of $38,755 over the life of the new loan.
Original mortgage interest from refinancing date to end with extra payments = $89,755
Less: New mortgage interest from refinancing date to end = $51,000
Equals: Interest savings over the life of the loan assuming the same monthly payment = $38,755
This didn’t factor in applicable closing costs or other fees, a shorter time frame for those that don’t stay in their homes for 30 years or other applicable considerations. That’s a post for another day!
It’s essential that you take charge of calculating your own personal information when it comes to your finances. Ignorance is never bliss when it comes to personal finance.
Don’t just use last year’s numbers or use rules of thumb such as “you should refinance if you can get a 1% rate lower than your current rate” or if the random guy at the bank tells you it’s a good idea (he’ll always benefit).
Calculate the numbers for yourself–you now have the knowledge to do it!