What if I told you, you could save TENS of THOUSANDS of dollars on your next home? Sounds impossible, right? But believe it or not, strategic payment of your mortgage can save tens or even hundreds of thousands of dollars in mortgage interest.
Just imagine what else you could be doing with that money?
Mortgages are “amortized,” which means that the payments are spread over the life of the loan equally to pay back the exact amount you borrowed (the principal balance), plus all the interest you owe. That way, the payments stay even throughout the term of the loan.
But, since the interest charged in each payment is based on the outstanding balance of your loan (and the loan balance decreases over time), the payments at the beginning of the loan term have a proportionally high amount of interest. Very little of your early payments goe toward the balance you owe. Paying extra principal, even just a little, at the beginning of the loan saves you interest for EACH SUBSEQUENT PAYMENT for the rest of the loan term. A little can go a LONG way. Your monthly payments won't change, but your loan will be paid off much more quickly, with fewer dollars spent.
Here are some of the best ways make those extra payments seem painless:
Increase your automatic monthly payment by a small amount, right from the start of the loan. Round up to the nearest 100, or add a manageable amount (like 10 or 20%) You will get used to the payment right from the start, and the savings can REALLY add up! If you have a 30-year loan principal and interest payment of $1000 but choose to pay $1200 instead, at recently prevailing terms, you will pay off your loan 8-10 years early, saving more than $40,000-70,000 or more in interest!
Make Just ONE extra payment per year. Usually get a tax refund or an annual bonus? Double your payment that month. Making just ONE additional payment per year can shave 4-6 years off your loan term.
Do you have Private Mortgage Insurance (PMI) added to your payment? If you made a down payment of less than 20%, your loan might have been required to carry extra insurance for the lender – money paid each month within your loan payment. With most loan programs, the PMI terminates when the balance of your loan gets to a certain threshold, like 78% of the purchase price or property value. The faster you pay down your loan in the beginning, the earlier the PMI payment ends, potentially decreasing your monthly payment by hundreds of dollars. Applying extra savings to the loan payments at the beginning of a loan with PMI not only saves you thousands of dollars of interest down the line, but it can also keep you from paying thousands of dollars worth of private mortgage insurance, too!
Let's Get Down to The Numbers
Exactly how much are we talking about in saving in plain numbers? Let's say you had a $500,000 30-year home loan with an interest rate of 5%.
|Additional Monthly Payment||Total Savings|
Holy Smokes, that's a LOT of Savings!
NOTE: I didn’t use the “biweekly” payment, because while yes, paying biweekly ends up being 13 payments per year instead of 12 (52 weeks in a year), the plan isn’t widely available. Most banks, if you send biweekly payments, wait until the end of the month to apply all the payments to the principal balance. To get real savings, the bank has to credit you for the interest payment at the midmonth and not charge interest on that half of the payment and most here in the US won't bother to do that number of resets and calculations in a year. A few do, but not most, and so the term can be misleading.
Want to see what paying a little extra principal could save you over time? Here are a could handy online calculators to try:
Mortgage Payoff Calculator
Google Play: Karl's Mortgage Calculator