Loan Payoff Strategy #3

When it comes to paying off loans typically there are 2 typical ways to work through the problem, which we can look at some alternate strategies, there is even a 3rd unorthodox way to paying off faster potentially. Today we will look at strategy #3 the most off path ideas.


3. Change the value of money.

Strategy #3
To accomplish strategy #3 we figure out a way to change the value of money. What this means is that if you have a dollar how can you make that dollar worth $1.50 or say you have a loan of $1.50 how can you make what you owe only $1.00?

Foreign Currency Mortgage
There exists a strategy which can be risky, but it's reward can payoff quite large. Instead of taking a loan in the same currency as you earn, you obtain a loan in a different currency. This is referred to as a foreign currency mortgage.

Let me give you an example. Suppose you decide you want to take out a foreign currency mortgage. The current exchange rate for yen to dollars is about 100 yen per dollar. So imagine you take out a loan for 10,000,000 yen at say 4% interest. This sounds like a lot but bare with me. Lets say your monthly payment is 1200 dollars over say 30 years (or until paid off).

Ok so the first month you get the loan you pay exchange your $1200 for 120,000 yen. Your loan is paid off some (as with any loan). Now between today and the next mortgage payment the value of the yen goes down, now the exchange rate is 110 yen to an american dollar. This means that the next mortgage payment you make of $1200 comes out to 132,000 yen. Whoa, without doing anything you just paid off an extra 12,000 yen on your loan. As long as the currency keeps devaluing you pay more with every payment. BUT WAIT, there is something more. Lets say you decide after month 1 to convert back to US dollars. Now you have a loan (lets assume you still have the full loan for ease of calculations). of 10,000,000 yen that converting back to US dollars comes to 90,9090. This means that if the currency changes by 10% your loan value changes by 10%. You have just changed the value of your money.

You can read more about it here on wikipedia;
https://en.wikipedia.org/wiki/Foreign_currency_mortgage

Foreign Loan
So another idea related to this and strategy #2 is looking for a loan. While the previous idea talks about taking the loan in another currency (in the US), this strategy looks at taking a loan in another country. Here we find a stable currency with a lower interest rate. This would enable you to pay less on interest, but you still need to deal with conversion.

Drawbacks
While there are some obvious benefits, there are also some pretty big drawbacks to these approaches. If for some reason the value of the currency you are converting to has gone up, this will cause problems with the goal of reducing the value of the loan, and/or increasing the value of your dollar. One approach I am interested in doing is analyzing currencies over time and determining whether the currency is likely to continue trending.

Loan Payoff Strategy #2

When it comes to paying off loans typically there are 2 typical ways to work through the problem, which we can look at some alternate strategies, there is even a 3rd unorthodox way to paying off faster potentially. Today we will look at strategy #2 and in future posts we will discuss the remaining strategies.

2. Pay less interest over the life of the loan.

Strategy #2
To accomplish strategy #2 you find a way to pay less interest. Well suppose like me you have a 7% interest loan, how do we reduce the interest rate? Well I also happen to have a poor loan to value ratio on my house, so refinancing adding in PMI may not save me a whole lot, so I need to find an unorthodox way to reduce the interest rate.

Credit Card Arbitrage
First up, depending on your credit worthiness, you might be able to take a credit card, that has a 0% interest rate and 0% balance transfer fee for 18 months and pay on that until the 18 months are up. At about month 16 you start looking and applying for another 18 month 0% interest credit card with 0% balance transfer fee, and transfer again. Paying for a 100k house in 18 months would require $5555 a month payments (approx), or for 36 months at $2777. Make it three 18 month periods and you're only paying out of pocket $1851 a month, while this is higher than a standard mortgage for a 100K house, you end up with a house you own outright paying less than $1900 a month for 4.5 years. You've also managed to buy that house INTEREST FREE. Meaning that if you decide to move or sell the house, it's pure profit, and it's not the we'll tax you until you have no more money, profit, my understanding is that the profit above what you bought the house for is taxed higher, but anything below either isn't taxed or is taxed at a normal rate, so you are barely touched.

Car Loan
This strategy I have not tried, so I don't even know if it would work, however the idea is interesting and I am tempted to see if I can make it work. I'll lay out the approach here. I am a married individual. Suppose I have a car worth 18K. I decide to sell that car to my wife and who takes a 1.75% loan on the 18K. Next, my wife has a car worth say another 18K and I take out a loan for 1.75%. Now we have nearly 36K in loans for 1.75% while this doesn't necessarily pay off the entire loan it does amount to a much lower overall interest rate when taking a 100K loan at 4.5% interest originally. The original loan would likely cost you $506 a month out of pocket, and another $627 over the 5 years on the 1.75% interest rate loan.

If we compare say just paying 627 extra a month on the loan.

The original loan would be at 90K approximately at 5 years if you just payed the minimum. If you payed the extra 627 a month you would end up with a balance of 48K on the loan, Instead, if you take the 36K loan for 5 years your original loan would be 45K after 5 years and you would pay 1624 in interest.

Rough numbers show that even though it's another loan you'd still save another 1.5K by the car loan strategy.

Whats more exciting about this strategy is that had you just paid the loan at the normal rate you would have paid 82K in interest. By paying the extra 627 a month for the life of the loan you reduce that number to 21K. Nearly reducing by 1/4. PLUS your loan is paid off after 9 years.

Taking the 36 month loan, and then paying the minimum, you'll end up paying 23K in interest. This means that you only pay 627 for 5 years and then just pay 509 a month for another 9 years.

So suppose you only want to pay extra for a little while then go to a normal monthly payment taking a car loan might make sense, but in reality for 4 more years of the extra 627 a month may make sense. Combining the two strategies might make even more sense. Suppose you take the car loan for the first 5 years reduce your loan to 45K, then pay 627 a month after. I am absolutely sure that you would save even more as the additional 627 a month on the lower principal would result in less overall interest. The calculators online don't give me that option, but I'll see if I can come up with a calculation in the near future.

204K Loan Payoff Graph

I just wanted to share a graph I recently built. I used finance.js (with tweaks, this can be found in my github repo).

The payments/interest,etc are all based on a loan of 204,800 with 4.5% at a 360 month loan (30 years).

I iterated through extra payments ranging from $0-$204,800 , however the graph flattens terribly, so I removed quite a few datapoints and show you the below. This is the range of payments from 0 to 10,000 extra a month, now clearly you wouldn't be paying 10K a month extra but I just wanted to make it obvious that just adding extra payments helps a lot it decays exponentially, but even small amounts net you big wins.



What I this chart tells us is that the difference in interest we save by making an extra $1000 a month payment vs a $3300 a month payment is about 31K, which to be fair is quite a bit, but in contrast the difference between an extra $500 and $1000 is about 26K, so you need to pay nearly exponentially (to a maximum) amount to improve your interest reduction over the life of the loan (clearly never taking a loan will save you money, but you would have to pay the loan the first day within the first smallest unit of time to accrue the smallest amount of interest, which would still not be 0).

EDIT:
Even more awesome, the difference of not paying extra and paying $500 extra a month is nearly 90K in interest..... thats a lot of change

Also the above graph is very similar to my last post but with more data to think about.
Extra Payments | Interest Saved:
0    0
100    31899.0253591402
200    53174.336807235
300    68502.370986308
400    80123.5001343135
500    89262.4827390045
600    96650.7126879693
700    102754.285037028
800    107885.551654743
900    112263.275018666
1000    116042.431216533
1100    119340.653830618
1200    122243.040919221
1300    124818.681888396
1400    127120.652481836
1500    129188.836046827
1600    131059.536893338
1700    132758.303299348
1800    134307.346171495
1900    135728.402567698
2000    137033.908384112
2100    138239.655204327
2200    139353.82667872
2300    140390.062724542
2400    141353.237802147
2500    142252.894075684
2600    143094.401651035
2700    143883.076315226
2800    144624.180047961
2900    145322.921528533
3000    145978.927437695
3100    146600.687453604
3200    147187.12681828
3300    147745.090514619

Loan Payoff Strategy #1

When it comes to paying off loans typically there are 2 typical ways to work through the problem, which we can look at some alternate strategies, there is even a 3rd unorthodox way to paying off faster potentially. Today we will look at strategy #1 and in future posts we will discuss the remaining strategies.

1. Pay more over the life of the loan.

Strategy #1
To accomplish strategy #1 you either have spare money and you pay off the loan faster, or you find a way to take extra work and pay off the loan faster.
This strategy works well, and of course the more spare money you have to throw at a problem the faster you can solve it, however it should be interesting to note, you can look at this strategy as a way of lowering your interest rate. Technically you aren't lowering your interest rate however, what you can do is say, I have a target of 1.75% interest rate on my loan, and pay enough extra so at the end of the loan you've paid the equivalent effective interest.

Effective Interest
Why would you want to do this? Well suppose you have a couple loans. Each loan paid till their full term has a rate. If you pay off that loan earlier than when considering the life of the loan you've reduced your overall interest. What this does is let you compare other loans, and realize that dumping *all* your money into one loan, and skipping over others may not be optimal. Lets use an example.

Suppose you have a loan for 100K that is at 4.5% interest rate, and a car loan for 18K at 2.75% interest rate. Our target is 1.75% interest rate on the home. and 1.75% interest rate on the car.

First we look and see that a 100K loan at 1.75% would run in terms of total interest.
28K is our goal interest paid for the life of the loan. Now when we look at this we have to basically ignore the payment and only consider the total interest. Looking at the loan's 4.5% interest rate we see we have a base payment of $506 and we will be paying 82K for interest, so a pretty big difference. To manually calculate this, we apply some amount of money on a monthly basis against the loan using a calculator and then look at what the resulting final interest is. This may take a little time, but once you figure it out, then you know your numbers.

In this scenario we pay off an extra $425 a month on our $509 a month loan and we will net an effective interest rate of 1.75% for the life of the loan. What's interesting is that if you look at the numbers, it's a non linear return in terms of money in vs interest saved. As shown below we can see we see a lot of benefit in our lower additional monthly payments, but it's a logarithmic strategy.



How I look at it is this way. Once I have reached my target interest rate on the home, we now restrategize on the car and begin to put more money on that.
For the car our loan would cost us $1286 in interest and to reduce to $812 is our goal. So we follow the same process and discover that if we pay about $165 we hit our target interest rate.

Of course this isn't a great analysis unless we look at how much interest we saved for each of the loans and compare the overall.

Loan 1 we paid an extra $425 and saved $54K in interest.  Loan 2 we paid an extra 160 and resulted in a savings of $400 in interest. Suppose we just paid the extra $160 on the home. Well this is only slightly an unfair comparison, if I apply the $160 to the loan, it'll go for the entire life (longer than 5 years which my calculations are based on).
 So even though it's a lot longer term of payments on the 160 it comes out to us paying 22K in interest so we save another nearly 6K.

What if we took that 160 a month and assumed it was really 160 * 5 * 12 (total amount paid extra on the loan over 5 years) it comes out to 9600, now we divide that by 12 and 30 to make that payment go across the life of the 30 year loan, so we paid the same extra, but just split it, that comes out to 26 bucks extra a month this comes out to paying closer to 27K which is very close to the 28K we are already saving, so you see that we save a tiny bit more averaged across on the higher interest rate loan, but it's very close to the same. I think that to make this comparison more equal there might need to be some normalization, and then we can really compare apples to oranges, I'll perhaps figure out how to do that in a future post.

Which is the right approach to take? It's a little inconclusive at this point, but hopefully we can build a case in the future.

What is this all about?

I'm an engineer, while I primarily work in software, I am often thinking about how frustrated I am that I pay thousands of dollars to a bank over years, if you're here you're thinking the same thing, how can I fix that?

How can we engineer becoming rich, instead of following the standard path? Are all of these good ideas? I don't know but we'll work through the problem here and perhaps find an optimal solution

The goal of this blog is to discuss unorthodox ways of thinking about money and economic problems, and working to engineer strategies to build wealth while paying less for interest, taxes, etc. 

Of course we can all become stock market millionaires, and that's great, however if you're like me, while I did ok overall, it wasn't really a big win for me. The certainty of paying off my loans faster gave me a more guaranteed return.

This is where we will start.

Join me in my journey in engineering rich.