So what is reverse compounding and how can it affect me? Before you know what it is you should have an understanding of why it is important.
If you are looking for the answer to this question then there is an easy way to explain it. Reverse compounding is a way to determine how much money you will save in interest by paying off your mortgage early. We all want to save money and this outlines exactly how you can go about it.
When you take out a home loan the interest rate you pay is multiplied by the amount you owe on the house. Compound interest is paid on the balance since the last payment was made. So, for example, if you made a payment every two weeks instead of once a month the interest would only have two weeks to accumulate instead of four.
You can accomplish a similar result by sending in extra money each month. The additional amount paid reduces the balance and reduces the interest amount you pay. If you ever find that you need the additional amount you are sending in then simply go back to the original agreement until you can start again.
Since you are also paying more on the principal balance the interest has a smaller amount to be compounded on. This saves you money again. This described method is the way to determine just how much you saved by changing your payment plan.
Why would you use this method? Because it saves you money versus other methods of modifying the loan. If you refinance you will have to pay origination fees and other costs associated with it. This accomplished the same thing. Also, when you refinance you are starting over with the length of time you will be making payments. This will continue you on your original time frame.
Some financial experts may try to advise you to take this additional money that you are saving and turn it around by re-investing it. The whole reason behind doing this program is to save money. By re-investing it you are tying it up again and taking a chance on it’s performance in another aspect.
So the next time someone asks what is reverse compounding you can tell them it is a way you are saving money by not paying unnecessary interest.
Related posts:
