Am I paying too much in mortgage interest?

Hi there all you smart people. I am looking for a hand on a mortgage I currently hold. I will give a little back story to hopefully let you see where I am coming from.

I have a summer home (the only property I own) and was unable to get a conventional mortgage on it through a bank. Basically because there is no power, a bad road and a trailer on the property not a house. That means no mortgage insurance places will insurance me for mortgage insurance. There's no getting around that so it's not to do with my question.

I ended up getting my rich boss to hold the mortgage for me. So he payed the \$264,000 that I owed to the previous owners and that is what I now owe him. I really wanted to keep it simple since he is doing me a favor by letting me pay him back slowly so we worked out a deal and he's pretty casual about it. He is holding the mortgage at 6% for me. I pay interest payments in cash. Instead of doing one of those mortgage calculators and getting a whole bunch of weird numbers to pay him, I just took.

Year 1 \$264,000 owing x 6% = \$15,840 So for that year I owed him \$15,840 in interest, as well as I could pay any large sum of money I wanted down towards the principal at the end of the year. That way I payed him 3 payments of (\$15,840 / 3 = \$5,280) for interest. (I did three separate interest payments so I wasn't bugging him looking for him to pay him a wad of cash every month for interest and I didn't have a years worth of interest saved up). Than I payed \$34,000 in principal.

Year 2 \$230,000 owing x 6% = \$13,800 So I did 3 payments of (13,800 / 3 = \$4600) and payed another \$30,000 in principal.

Year 3 \$200,000 owing x 6% = \$12,000

I am currently on year 3 and trying to save an extra \$30,000 but not sure if i will make it this year. Either way I have been talking with my partner and he keeps saying that I should be re-calculating the mortgage interest payment each month and not yearly. We all know paying your mortgage off bi weekly is better than monthly which is better than yearly. But I feel when I did the calculations, over the year we are only losing out on about 200\$. Yes substantial in a way but I am trying to keep this simple and not have to pay the mortgage holder with bills, loonies, and twoonies etc. since I pay him cash for the interest. However my husband thinks that the \$200 a year will actually compound hugely over the next 7 years till we are payed off fully on the property. I just don't feel that's right for some reason. It's not like we will put that extra \$200 dollars we save a year on interest into the principal we owe since we are trying to keep the numbers round and whole. And I feel like our "term" is yearly... So the \$200 a year won't compound like if somebody had a 5 year term?

Any insight is appreciated. I am finding this all a bit confusing when I use the mortgage calculators and having troubles working them to my weird situation (1 large principal payment a year and thrice yearly interest payments).

• "I am not sure how much of this he is claiming on his taxes so I pay interest payments in cash." I sure hope you're getting receipts... Mar 31, 2017 at 14:55
• Willful blindness may not be a good defense to a charge of participation in tax evasion... Mar 31, 2017 at 15:37
• I am not getting receipts. I know he gives our paperwork to his accountant. And it states everything I am paying. I am pretty sure he is paying everything fully. Being a business man he would be silly to not claim my small beans on his return and open up his huge empire to a tax. His accountant was adamant about wanting this all in writing before we had anything in place. Mar 31, 2017 at 15:42
• Get the receipts. Apr 1, 2017 at 0:34
• You should really get receipts! What if he later claims you never paid him? This whole arrangement seems to me, to be asking for trouble... Apr 1, 2017 at 3:45

Yes, you are paying extra in interest, but additionally, you are decreasing your payment each year, taking 21% longer to pay off the loan, which further increases the total interest you will pay. The first year, you paid \$49,840, but the second year you paid only \$43,800. The third year, you're decreasing your payment to \$42,000.

If you ran this like a regular mortgage, that first year you would have paid \$4153.33 each month, and at that rate you could have cleared the mortgage in 7 years and 5 months. You would have paid a little under \$55,000 in interest.

The way you are running this mortgage, if you keep paying \$30,000 in principal (that would leave \$20,000 in principal in the final [9th] year) you will pay \$75,840 in interest. That's about \$21,000 in extra interest so that you don't have to bother your boss with monthly payments (a pretty generous bonus just for the sake of being polite).

But hey, on the bright side, paying off your mortgage in 9 years is actually a pretty good accomplishment. It's not as good as 7 1/2 years, but it's much better than 30 years.

• I guess we hoped that we would be able to increase our principal each year that our monthly interest went down. We are making less and less as a household income now that we are expecting baby number 2 and I am a stay at home mom. Thats why this years \$30,000 might be hard for us. And next year even harder. We are finding the interest payments just so much this year. But even the interest in time in 7 1/2 years and 9 years is a big chunk of money you are saying. Like a huge chunk of money. Which makes me think I might need to try and use a mortgage calculator. Mar 31, 2017 at 15:34
• What do you suppose i should put into the mortgage calculator? Terms of 1 year still? Or do amortization of 7 years, 6% closed interest, bi weekly payments and look up the details of what that entails yearly for interest? Than maybe take my yearly numbers and crunch them into a timeframe of payments that I have now? Mar 31, 2017 at 15:38
• I would recommend that you use a regular loan calculator instead of a mortgage calculator because most mortgage calculators try to assume longer loan terms, etc. Since you are already 3 months into the year, consider 1.5% of the 200,000 principal is already owed in interest before calculating the paydown of the principal starting today. Mar 31, 2017 at 15:58
• By the way, paying every two weeks only speeds things up significantly because you are paying half of a monthly payment 26 times per year instead a full payment 12 times per year. It's like an extra payment every 12 months. If you can afford to pay at that rate, just pay 1/12th more on each monthly payment with pretty similar results. Mar 31, 2017 at 16:00
• @NathanL The reason some people might find the bi-weekly payments easier to manage than increasing their monthly rate is if they are already paid bi-weekly.
– user12515
Mar 31, 2017 at 18:11

There's one problem here. You've borrowed a substantial sum, but don't seem to have any agreement with the lender. We have a principal number and interest rate, sure, but a cavalier "pay me the interest, and whatever principal you can" set of terms.

Hubby's suggestion is accurate. The way a mortgage works is when I pay principal, the interest accrues on the new balance. But the difference is probably more than the \$200 you assume. Look at year 2. You paid \$30K in principal. If you paid it at the end, the point is moot, no need to talk further. But if paid over the year, the boss man had the \$30000 for an average of 6 months. And that's \$900 you lost.

One solution is to pay interest during the year, and pay the principal down in late December, only. That will keep to the loose terms of this loan, and keep the lost interest due to that lack of accounting to a minimum.

• Are you saying I lost \$900 because he also made interest on that money by having it in the bank? We actually pay the \$30,000 at the end of the term. So tequnically if we had the money we could make it in the bank? But we don't seem to have it in our account till that year is up anyways. But your saying perhaps doing the principal amount in 2 chunks would help? Thanks. Mar 31, 2017 at 15:46
• As I wrote, if you pay that \$30,000 at year end, there's no issue at all. Of course, if you paid it, say, in June, and then calculated interest on the balance, you'd pay \$900 less. \$15,000 in june, \$450 less. It's simple arithmetic. Mar 31, 2017 at 15:57
• Thank you I see what your saying. If my term was not a year and perhaps pay the principal twice yearly at \$15000 a piece it would help. Mar 31, 2017 at 20:56

How much do you trust your boss? How much does he trust you? What happens if you (or he) are fired or find a better job? If all of the interest payments are in cash, how can he prove how much principal or you paid? How can you prove how much interest you've paid so you can deduct it? Is there a term for the loan or do you just keep paying until it's paid off? There are many things that could go wrong with this arrangement.

I would immediately set a time to meet with your boss and get a more formal agreement in writing. It's not just for your protection, but for his as well. You could stop paying the mortgage altogether and he could have a tough time proving that you owe him anything. He also needs an actual mortgage to ensure that the house is properly collateralizing the loan.

You can have a loan that compounds annually, so that's not a problem. You can even make the principal payments flexible rather than being on a fixed amortization schedule. If you both agree to that, then your calculations are correct. Pay a year's worth of interest over the year, pay some extra amount in principal, and recalculate the next year's interest based on the principal remaining. The more you pay in principal the aster you pay the loan off. Yes, you would save a little bit by paying monthly and recalculating interest, but it may be worth it for the convenience and simplicity that you have.

It may be awkward having an actual signed contract between you, but it's in BOTH of your best interests to do so. If he is not comfortable doing so, then go to a bank and get a traditional mortgage. If he's as rich as you say he is, then he should be smart and/or experienced enough to know the value of a contract, even between friends, and know that it doesn't mean a lack of trust.

Finally, if mortgage insurance is the deal-breaker then just make sure you don't borrow more then 80% of the value of the home. Most banks will not require mortgage insurance if you have a Loan-to-Value (LTV) ratio of 80% or lower. If you need to borrow some money from your boss to cover the 20% then that might be viable, but I would pay that off as quickly as possible.

• Hello, thankfully we have a contract in place. I found a free one online and mention everything i stated above, I replace the numbers with accurate ones every year and we both have the contract. I am not worried about him, and him not worried about us. We actually feel pretty safe with him since if me or my partner died, I know he would let us not pay interest for a few months. This is really not much money for him, just us. Mar 31, 2017 at 15:29
• I always thought the LTV thing was real as well. But every time I go to different banks they get excited looking at our LTV saying that they should be able to do something for us (since it's so good and appraised at what we paid). But it always comes back to they don't want to risk it on our property. It's really too bad. We have paid off so much. Mar 31, 2017 at 15:30
• @JollyGoodTime the problem could be that they don't know the true market value or it's such a niche property they would have a tough time selling it in a foreclosure. Mar 31, 2017 at 15:47
• Yeah it sorta makes sense. With there being no power, for them to shut down our place for the year (close it up to sell it), they would have to hire a professional. Plus nobody can get to the property for 5 months of the year as well. So i sorta get it. But still we have so much paid off! I would think the risk would be small. Mar 31, 2017 at 15:49
• Are you asking about homeowners insurance or mortgage insurance? Those are completely separate issues. Mar 31, 2017 at 16:50

In short, unless your contract specifies otherwise, you should be recalculating the interest and principal with each payment.

It sounds as if you are doing quarterly payments, with a larger payment at the end of the year.

So as you described the payments for year one, starting with a balance of \$264,000, you paid \$5,280 at the end of the first quarter, but only \$3,960 worth of interest had accrued at that point. Meaning the extra \$1,320 should have applied to principal at this point. Principal balance = \$262,680

With that reduction in principal, the interest accrued at the end of the second quarter would be down to \$3,940.20, meaning that \$1,339.80 of your \$5,280 for the second quarter should have gone to principal. Principal balance = \$261,340.20

For the third quarter your accrued interest would have been \$3,920.10, giving another \$1,359.90 to principal for the third quarter payment. Principal balance = \$259,980.30

Then in the forth quarter you paid \$34,000. The accrued interest at this point would have been \$3,899.70, leaving \$30,100.30 to apply to principal. Principal balance = \$229,880

As compared to the \$230,000 balance you calculated. So calculating things this way would have reduced your principal an extra \$120 in the first year using the same payment pattern. However if you had spread things out and made 4 equal payments of \$12,460 each quarter, your principal would have been down to \$229,227.30, or \$772.70 ahead of the way you did it.

While these "savings" numbers don't seem too significant in terms of the overall picture. They do add up to a decent amount over the full course of a loan. In general, your goal with paying off any loan should be to reduce the principal as soon, and as often, as you can.

EDIT

Just for grins I ran a few more numbers and thought I would share them with you. I rounded a bit from your actual numbers so they are not an exact match, but they are still useful for illustrating the point.

Lets start with your \$264,000 loan, and say you made total of \$41,000 combined principal & interest payments per year with a 6% APR. After 4 years you will have paid \$164,000 into your loan. The question is, what will the principal be at that time? And how much of your \$164,000 went to interest?

Making a single \$41,000 payment per year, which is essentially what you have been doing. Your balance at the end of 4 years is \$153,934.66, with \$53,934.66 having gone to interest.

Making four payments of \$10,250 evenly spaced in the year. Your balance at the end of 4 years is \$151,205.38, with \$51,205.38 having gone to interest. An improvement of \$2,729.28 over the single payment/year.

Making twelve monthly payments of \$3,416.67. Your balance at the end of 4 years is \$150,574.91, with \$50,574.91 having gone to interest. An improvement of \$3,359.75 over the single payment/year, or \$630.47 over the quarterly plan.

• Thank you for doing that math. I tried doing it long hand and noticed that the numbers just really did not seem that huge. I hadn't thought about perhaps doing principal payments four times a year. Not thinking it would change too much. Its wonderful to have the math there for me too look at. My husband would definitely agree that \$700 is huge and why the hell are we wasting our money like that. Looks like we have a lot to think about on how we are going to do this. I appreciate your help. Mar 31, 2017 at 21:03
• @JollyGoodTime check the edit for further examples. More frequent payments would get you further ahead, but the rate of change decreases as you move to smaller and smaller time increments. Mar 31, 2017 at 23:22