Occasionally, I like to play professor by answering some of the more-interesting questions I have received. The ones I respond to below are all interesting for different reasons.
Q: What is “reversed” in a reverse mortgage?
A: The reversal is in the typical pattern of loan-balance change.
On a standard mortgage, the balance usually is at its highest point when the loan is made, declining steadily thereafter until it reaches zero at the end of the term or when the balance is prepaid. On a reverse mortgage, in contrast, the initial loan balance is relatively low and grows over time as borrowers draw funds and as interest adds to it.
Related to the reversal in loan-balance change is reversal in payment flows. On a standard mortgage, the borrower is required to make a monthly payment, whereas the reverse mortgage borrower has an option to draw a monthly payment or irregular amounts against a credit line.
Q: If I double my mortgage payment, can I skip a month?
A: You can skip a month if you inform your servicer that one payment is for the current month and the second payment is for the following month. That isn’t exactly “skipping it.” It’s better described as paying the second month in advance.
If your intention is to pay off the loan sooner by having the entire second payment credited to principal, then you cannot use it to pay in advance. You can pay in advance, or you can pay down the loan balance faster, but you can’t do both with the same payment.
What you can do is make sure that what happens with your payments is what you want to happen. If you want to pay in advance, write two checks for the payment amount, each with the notation “payment for (name of month).” If you want to pay down the balance, write “apply to principal” on the check and make sure that the designated amount is not exactly equal to the monthly payment.
Q: Is interest on home mortgages front-end loaded?
A: I received this question in a letter in which a reader stated that since most of the interest collected on a home mortgage is collected in the early years, and the typical loan has a life of about seven years, the true rate of return must be much higher than the stated interest rate. He wanted to know whether I had developed a calculator that would allow him to measure the “true rate of return.”
The idea that since home mortgages are front-end loaded, lenders must be earning more than the stated interest rate is an old myth that has not a shred of validity yet never goes away.
Most mortgages written today call for equal payments that fully amortize the loan. This necessarily means that in the early years, most of the payment is interest, and in later years, most of it is principal. But the years of high interest payments are the years when the loan balance is high. If the interest rate on a 30-year $100,000 loan is 6 percent, in month 1 the interest payment is 0.06 divided by 12 and then multiplied by 100,000, or $500.
After 25 years, the interest payment is down to $155, but that’s because the balance is then only $31,000. The dollars of interest earned in month 1 and the dollars of interest earned in month 300 are both equal to 0.5 percent of the amounts owed in those months.
Q: Do you make loans in South Africa?
A: No, I don’t lend anywhere. The reader who asked this saw my name on a website called Behance in South Africa, where a scamster from Nigeria who calls himself Jack Guttentag promises a “Financial Solution For Those in Need of HELP.” At various times he has operated under my name in real estate-related sites in Laos, Ecuador and Canada. His game plan is to offer loans at very low interest rates to people whose capacity to repay he makes little effort to assess, charging an upfront fee but never delivering the loan.
I know he is from Nigeria because in Laos a potential victim in his pipeline contacted me by mistake — a fortunate mistake for him because I saved him from paying the fee. That potential victim had received official looking documents by the scamster and one of them allowed me to trace him to Nigeria.
If any reader has an idea about how to stop this guy, I would love to hear it. But don’t tell me to contact the website because there is no way to contact whoever manages the site for any purpose other than posting and responding to ads. And don’t tell me to contact the Nigerian authorities, because that would be an exercise in futility.
About the Writer
Jack Guttentag is professor emeritus of finance at the Wharton School of the University of Pennsylvania.
