Interest Paid….is Interest Paid

Given a certain loan amount and a certain period of time, a good question to ask is which loan program would allow me to pay the least amount of interest over the set period of time? Let’s put it into actual numbers.
Assume the following:
- $230k loan amount
- 6.125% interest rate
- 5 year time period in which you will pay the loan off

On a 30-year fixed loan, at the end of 5 years, I will have paid $69,356 in interest. …unfortunately …I still have 25 years left of payments before the loan is paid off. On Bankrate.com’s website, it allows you to add a monthly extra payment. I found that by adding $3000 extra per month, I’d have the loan paid off by the end of 5 years which in turn means I’ll “only” have paid $38,272 in interest.

So how does that compare to the interest only loans. My first thought was, if the interest rate is the same, the time period is the same and the amount is the same…the interest you pay should be the same as well. On an interest only loan that is recalculated monthly, you’d have to make $3770.49 in principle payments each month to pay it off by the end of 5 years. You’ll pay a total of $36,373 in interest. …all righty … pretty close to the fixed loan. So I feel fairly confident that my original assessment was correct. Doesn’t matter the loan, if the other variables are the same..you’ll be paying roughly the same amount of interest.

But…I got thinking. What if I paid more of the principle earlier in the 5 years? Or what if I paid less frequently, but just bigger payments? Here’s what I was surprised to find.

If I made quarterly payments of $11,500, I’d end up paying $35,864 in interest. If I made five huge payments of $46,000 each spread out randomly over the 5 years (I had 3 of the 5 payments within the first 2 years and the last 2 payments in the last year) I’ll have paid $34,749 in interest. If I made random sized monthly payments throughout the 5 years (payments ranging from $1000 to $25,000), I’ll end up paying $35,505 in interest. Hmmmmm…

The key factor in this that I’ve deduced is the time frame. If I paid off the loan in 2 years, the amount of interest I would have paid would be far less…but because all of these scenarios were constrained to 5 years…they all ended up to be essentially the same.

So what? Well, if you’re trying to decide between a fixed and an interest only loan and you want to pay off the loan early (…which is not what I would do), then this would tell you that it kinda doesn’t matter what you pick. You’ll end up paying roughly the same amount. So if you have a time-line to hit, doing it in equal payments vs big lump sums (like after you get a bonus check) ….won’t matter in the end. ..unless you want to bring the timeline in some.