The Never Ending Note
Here is the technique that you will often see at this time of the year. To get you into the Holiday Spirit, often mortgage or finance companies will send you a card that says “Ho, Ho, Ho!! Merry Christmas!!! Since you are a valued customer, and we know how Christmas can be a financial burden on you, we are going to play Santa Clause and allow you to skip the December payment, so you will have more money for holiday gifts. We will just add your payment on to your balance, and you can resume making payments in January”.
Sounds good, doesn’t it? Well, if you are financially embarrassed at Christmas time, it might appear to be a generous offer. Why would they allow you to skip a payment? Out of the goodness of their heart, right? Nope, let’s look.
Say you had a $100,000 mortgage @ 7% for 30 years with payments (PITI) of $665.30.beginning in January. In November after 11 payments, your balance is $99,071.58. So you decide to take up the mortgage company’s offer and skip the December payment. This innocent act causes $665.30 to be added back to your balance. In the following January, instead of your balance being $98,896.32 (with a December payment), your balance is $99,561.60. Not much of a difference you say? Well, plug this amount into PV (Present Value), and look at what happens to N (Number of Payments). You have added 9 more months of payments to your loan. In essence you now have 357 months to pay off this loan, instead of 348 months.
Use Your Calculator
Start playing with your calculator and you will see that by allowing the payor to skip one payment a year, and adding the payment to the balance, this not only increases the balance, but also increases the amount of time to pay off the loan. When credit card companies or finance companies apply this technique to revolving credit, how long will it take to pay off a debt? I am reminded of a Johnny Mathis song, “Until The Twelfth of Never“, and that’s a long, long time. Finance companies, want a performing note on the books for as long as possible. Every extra payment adds to their cash flow. By allowing you to skip one payment a year, this extends their cash flow. Meaning additional interest for you to pay and pay and pay.
Remember, “Let your money work for you, not against you”.