This is a common misconception. - Posted by MDonovan

Posted by MDonovan on May 11, 2000 at 12:53:27:

Its easy to understand amortization if you know the basic idea behind it. The interest paid during any period is figured by multiplying the interest rate by the remaining balance. Any additional amount included in the payment will reduce the remaining balance.

Example: 30 years (360 periods), 12%, $100,000.

Payment will be $1028.61. The first payment is computed by taking the balance (100,000) and multiplying the interest for one month (1%) giving $1000 interest paid. The remainder (28.61) reduces the balance to $99,971.40. So the second payment is 1% of this (999.71) for interest and the remainder (28.90) reduces the balance to $99,942.50. And so on…

So, if we look at the payment at the start of year 15, or half way through, the balance is $85,705.71. So our payment is 857.06 for interest and $171.55 applied to the remaining principle. Now lets say we re-finance a new loan at the same terms: $85,705.71 balance, 12% interest, 30 years. The payment would be $881.58. But notice that the actual interest paid is still the same: $85,705.71 times 1% = $857.06. So if you sent in the same payment amount as before, you would be paying the same amount to the remaining balance, and it would pay off in the remaining 15 years.

So you see there is no front loading disadvantage when refinancing (other than points and fees).

Just remember that the payment applies to this month’s interest, the remainder to the balance.

MDonovan