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Old 09-23-2009, 06:45 AM
 
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Default Truth in Lending - Refund of Finance Charge

Just opening up a discussion on the pre-payment section, in particular the 2nd line - "will not be entitled to a refund of part of the finance charge".

I understood this to mean if I pay off the loan early, I will not be entitled to any refund of the interest that I've already paid. Since mortgage payments are structured in such a way that it is interest-heavy in the beginning and principal-heavy towards the end, this feels like we're getting the (much) shorter end of the stick when we pay off the loan early. Mathematically, the earlier you pay off the loan, the more expensive your loan actually is.

Question: Has anyone come across a loan where they DO refund the finance charge depending on how long you hold the loan before full repayment? And which is more common, where finance charges are refunded or where they are not?
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Old 09-23-2009, 08:50 AM
 
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I think you may have a major misunderstanding of what early payoff accomplishes.

Should you have the ability to fully repay the principal of your mortgage your relationship with the lender is complete -- you own the house free and clear.

The language you cite is pretty standard and exists only to ensure that any interest you have paid CANNOT BE refunded no matter how soon you pay off the mortgage. The loan document you sign clearly show the method of interest calculation and by law has to have an standard amortization schedule shown / made available. While the "back calculation" might show that at certain points in time the total interest charge is higher than the APR based on early pay off that does not change the fact that you entered into a contract to pay the lender. If you have a great big pile of cash you need not talk to lenders at all. If you need only a tiny bit of cash, or have only short term needs for cash, there are numerous other loan products that would result in less interest, however they might carry other risk or fees (the products I am thinking of include interest only loans, negative amortization loans, hybrid option loans and a whole mess of other things that clearly were sold to folks that did not understand the implications and thus the firms that offered them have mostly vanished / imploded, but if the OP wants to do the leg work I bet there are goofs out that will still try and offer 'em...)

While you are correct about the structure of the fixed payments for traditonal US style 30 year (or 15 or 20 or 40) loans being biased toward only small principal portions early on, there is really no "short end" of the deal. The lender has significantly higher administrative costs upfront, and greater risk of default. The borrower almost certainly will have more earnings latter in their life and the risk of prepayment (which may also coincide with higher interest rates) is offset by reduced interest deduction. The system is well adapted to the tax and lifestyle needs of majority of Americans. The quicker you payoff the mortgage the less out of pocket you send to the lender over the life of the loan. If you want to accelerate the principal payments by routinely sending an amount greater than the minimum that is an option, as is a lump sum, or any combination.

The lender needs to be "made whole" for the amount that they gave you to buy your home. The are in business to make a profit by lending money. The interest they agree to charge you over the life of the loan is adequately disclosed and quite competitive.

While there is some technical truth that the 'interest expense' of the early years of your mortgage is a larger percentage than under formula to calculate long term loans, the formulae used in other places (like Canada) is not signficantly more consumer friendly. The time/value assumptions of how 30 year mortgages are calculated are well accepted and widely studied.

Additionally there are several ways to restructure your own payments, including creative uses of HELOCs and other instruments that could result in a significantly lower theoretical total interest charge, however as these instruments are variable rate the risk of rates going against you and some fees to setup a loan may wipe out potential savings...
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Old 09-23-2009, 09:24 AM
 
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Chet,

Thanks for the detailed response. I fully understand that there are benefits to early pay-off, e.g. owning the house full and clear as you've said, and more importantly, not having to pay the interest for the rest of the term.

What I am saying however, is since the mortgage payments are structured to be interest-heavy in the beginning, at any point of early repayment, the borrower would actually have paid more interest than what had been accrued until that point in time. The lenders would have been made whole and then some. They would have received all of the principal, all interest paid, which includes accrued and not.

Take for example, a $100K fixed 30 year loan with an interest rate of 5%. Standard mortgage payments are structured so that borrower would pay a total of $1,475 down towards the principal and $4,966 down towards the interest in the 1st year. If the borrower were to pay off the entire loan by the end of the 1st year (12 equal installments), the actual interest on a $100K loan at 5% only works out to be $2,728. The difference in interest is $2,238 which has not yet accrued but yet will not be refunded cause it has already been paid.

This probably is standard practice as you said but I'm just working this through as I go through the home-buying process.
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Old 09-23-2009, 09:34 AM
 
Location: Plano, Texas
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I have never heard or seen any lenders offering a refund of the interest. So what you are seeking as far as i know does not exist.
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Old 09-23-2009, 10:06 AM
 
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BetaTester: I completely understand where your line of questioning is coming from. In fact, I received my TIL statement today, and while reading that section, I had a similar question. I wondered to myself if any lender would ever refund part of the interest… and if no lender ever would – why on earth would that option even be on the statement. If there’s no lender out there that would ever ‘check that box’ – take it off! But I also understand what Chet is saying – and it appears that you do as well.


I’m a first time homebuyer – and a financial analyst by profession – and I try to look at and analyze every figure and word that I see in these documents. I have realized that understanding the terms and lingo is half of the battle – accepting some of the terms and lingo for what it’s worth is the other half. In my eyes (and yours it seems) it doesn’t necessarily seem like a “fair” deal b/c they aren’t truly getting the amount of interest that is equal to that rate for those years that you are paying on the mortgage. If you pay it off early it seems like the lender should only get the interest for the time that you were paying (the amount accrued), however, like VictorBurek says it doesn’t appear to exist.


I know this reply didn’t bring any extra knowledge to the table – but I just wanted to write to let you know that your questions makes sense to me and thanks for asking it b/c I’ve learned something from it.
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Old 09-23-2009, 10:10 AM
 
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You are most definitely welcome! It's great to know at least someone else is finding this thread useful.
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Old 09-24-2009, 10:52 AM
 
904 posts, read 2,329,272 times
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Quote:
Originally Posted by betatester View Post
Chet,

Thanks for the detailed response. I fully understand that there are benefits to early pay-off, e.g. owning the house full and clear as you've said, and more importantly, not having to pay the interest for the rest of the term.

What I am saying however, is since the mortgage payments are structured to be interest-heavy in the beginning, at any point of early repayment, the borrower would actually have paid more interest than what had been accrued until that point in time. The lenders would have been made whole and then some. They would have received all of the principal, all interest paid, which includes accrued and not.

Take for example, a $100K fixed 30 year loan with an interest rate of 5%. Standard mortgage payments are structured so that borrower would pay a total of $1,475 down towards the principal and $4,966 down towards the interest in the 1st year. If the borrower were to pay off the entire loan by the end of the 1st year (12 equal installments), the actual interest on a $100K loan at 5% only works out to be $2,728. The difference in interest is $2,238 which has not yet accrued but yet will not be refunded cause it has already been paid.

This probably is standard practice as you said but I'm just working this through as I go through the home-buying process.
Betatester,

Do you know how to amortize a loan? If not, try to learn it. You will understand how interests are calculated and your questions will be answered. Or am I missing something?
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Old 09-24-2009, 02:18 PM
 
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acegolfer,

The numbers provided (1st year interest vs principal paydown) in my previous post is from the amortization schedule. What numbers do you have? What am I missing?
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Old 09-29-2009, 11:52 AM
 
904 posts, read 2,329,272 times
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Quote:
Originally Posted by betatester View Post
Take for example, a $100K fixed 30 year loan with an interest rate of 5%. Standard mortgage payments are structured so that borrower would pay a total of $1,475 down towards the principal and $4,966 down towards the interest in the 1st year. If the borrower were to pay off the entire loan by the end of the 1st year (12 equal installments), the actual interest on a $100K loan at 5% only works out to be $2,728. The difference in interest is $2,238 which has not yet accrued but yet will not be refunded cause it has already been paid.
Betatester,

Do you know that the mortgage interest are paid in arrears? For example, your May 1st payment covers the interest from April 1st to April 30th.

So you only pay the interest that has actually accrued. Using your number, $4,966 is the accrued interest. There's no yet accrued amount as you claim.
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Old 11-04-2009, 10:52 PM
 
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Quote:
Originally Posted by betatester View Post
acegolfer,

The numbers provided (1st year interest vs principal paydown) in my previous post is from the amortization schedule. What numbers do you have? What am I missing?
The portion of your payment that is interest is based on your interest rate and the amount you owed before the payment was made.

Example: If you owe 100,000 and your rate is 5%, your interest payment will be 100,000 * .05 / 12 = $416.67. The remaining part of the payment goes towards principal. This is the same whether you just started a $100K mortgage or you have payed a 200K mortgage down to 100K over a few years.
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