For most homeowners a mortgage is just a fact of life. You get a loan and then make monthly payments for what seems like an eternity. It’s not all that bad because it does put a roof over your head and you’re using leverage to buy something that could otherwise take decades to save up for and you may even get a nice little tax break or two. But in the end, a typical 30-year mortgage is incredibly expensive.
Take a simple $175,000 loan at 5% over thirty years. Over the life of the loan you’ll pay nearly $165,000 in interest alone. Even if it’s spread out over three decades, that’s a lot of money. There’s always the option of refinancing, but that often reduces your monthly payment just a little and then extends your loan even further into the future. The good news is that with low refinance mortgage rates you can save more now than you could in the past. One way people save is by opting for a shorter term loan like a 15-year mortgage. You pay off the loan in half the time, save about half the interest otherwise spent on a 30-year, but the monthly payment goes up quite a bit. This can be a problem when you run into problems with income. That monthly payment can be hard to keep up with if you lose or have to change jobs.
So, how can you take a typical 30-year mortgage and still pay it off in less time, save money on interest, yet have the flexibility so that you might not be in such a bind if you have income trouble? Just make extra payments! As long as your loan doesn’t have a ridiculous prepayment penalty you can apply extra money to each of your monthly payments, make lump sum payments, or any combination of those and have it applied directly to the principal of your loan. This means you end up paying less interest and the loan gets paid off sooner. But how much can it really help?
Using the $175,000 loan at 5% example above, let’s say you make the equivalent of just one extra full payment each year. You might spread this out so you’re only paying an extra $80 each month or once a year make a lump sum payment for about $950 or so, but either way, if you do this every year you’ll shave about 4 years off of the loan and save yourself nearly $30,000 in interest! If you were to pay a flat $200 extra on each monthly payment for this loan you’d shave about 10 years and $60,000 off the loan! That’s certainly not chump change. And even if you don’t remain in the house for the life of the loan, remember, all this extra money is being applied to the principal and building equity. So even if you do have to sell after a few years that means even more money in your pocket when you do sell.
All that being said, I’m curious to see how many people are currently making extra payments on their mortgage. We’re making small added payments to our primary residence right now, but since we still have another house (and mortgage) we’re trying to sell it’s pretty tough to make the size payments we’d like. But as soon as we can free up that money I’d like to apply most of that to the current mortgage and be on track to pay off this house in just 10 years or so. So, what do you do?
Author: Jeremy Vohwinkle
My name is Jeremy Vohwinkle, and I’ve spent a number of years working in the finance industry providing financial advice to regular investors and those participating in employer-sponsored retirement plans.
I voted 'No. I prefer to put extra money in savings or investments.' Although I am not much of an investor by any means (at least not yet; right now I'm just focused on saving for life and retirement)I don't see the benefit of paying putting extra on the mortgage for someone like me. I bought a house that I could afford and one that I love. It's a one bedroom/one bath house with a detached in-law suite (with a kitchen/bath/laundryroom) so it is not a house for a family to grow into. I am still young (26) and I have good reason to believe I would not see this house to the end of the mortgage (even if I put every extra penny towards extra payments, on my single, meager income, it would still take 10 plus years to pay it off). I am currently one year into a $63,000 30year 5.375% fixed rate mortgage and my monthly payment, which includes principal/interest, insurance, and taxes) is still hundreds of dollars less than rent for the same house, so I already feel ahead, even if 100% were to be going towards interest (which it's not). I have a roommate living in the detached suite that pays for all of our utilities + internet as part of the living agreement. Mine is a case of using a mortgage as a tool, a tool I'm willing to pay for because it's useful.
Back to my original leading question before I went off on a tangent---What is the point of paying extra on a mortgage you don't intend to reach the end of before selling? All of the examples I've ever seen given indicate a savings on interest AT THE END of the term. I'm still researching info about mortgages because even after a year into my first mortgage I still feel lost when it comes to amortization calculations. How often, or does the interest on a fixed rate loan get applied to the current principle? Meaning, if I pay extra on my principle, will the percentage of next months interest be based on the remaining principal? I can see that being worth paying extra on a mortgage you don't plan on paying off. But I haven't seen any examples, or explanations on if this is a common practice.
Having more equity does nothing to motivate me because my equity has no bearing on the value of the house. It's going to go up, or down no matter how much extra I pay. I also don't need a forced savings; I spend what I intend to spend, and I save what I intend to save. It's not an incentive to me to give someone $10/month for 10 months and then they give me $100 in the 11th month. Great, you gave me exactly what I gave you, except you got to earn interest on it and I lost interest on it. That's how I see getting the extra principle back on a sale, but without saving on interest--you already save yourself from not having to pay x amount of years of interest by selling the house before the term was up, so it seems like a moot point. Hmm, I'd rather use my money to help increase the value of my home with repairs/upgrades, towards retirement and/or other investments, or just enjoying life without sacrificing hard just to come out even in the end.
No, but we make 26 payments a year biweekly, instead of 12 monthly payments. That's one extra month's payment a year.
I pay nothing extra. I invest all the extra including any equity I may have in my home. This allows me to take the biggest tax break I can get each year. It also has allowed me to have a 7 figure investment portfolio. I plan to keep the mortgage until I die. What other tax break will I have in my 70's while I take distributions from my 401k's. A 4.25% 30 yr mortgage is pretty cheap money.
This way may not be for everyone but financally I am in great shape. I have two years of cash and gov't bonds for cash flow. The rest is in long term stocks.
Just remember that there are other ways. Just because you think you are right doesn't necessarily mean you are right.
This doesn't help people already with mortgages.. but a key part of being able to afford extra repayments on your mortgage is to borrow less instead of stretching yourself too thin. When I went for my mortgage 2 years ago, the bank offered to lend me up to 800k. I opted to get a smaller place and borrowed just 230k. I've paid back my mortgage like it was a 800k one though, and will be debt free by next year.
Although I have a lower rate of 4.75% on a 30 yr mortgage, I am paying extra each month to get rid of PMI and also to pay off the mortgage early. I could have used the extra money to increase contributions to my emergency fund or ROTH IRA but it is psychologically important for me to pay the house off.
We're still working on building our emergency fund right now. Any extra money is going toward that. In the mean time we refinanced to a 15yr mortgage. We plan to start shoveling money toward the mortgage after w're done with the emergency fun. In the mean time we're also balancing all this with investing for retirement. We should have the mortgage paid off in about 8 years by our calculations. Can't wait!!
Our extras always go toward the mortgage because it will have SUCH emotional satisfaction when we no longer have to make that monthly payment.
I am just rounding up for now, I have a need for additional liquidity right now plus other debts I'd like to get rid of first.
At the time of writing, I currently don't own a mortgage. I plan on knocking off a huge chunk of it via investments and savings before I actually saddle myself with a standalone mortgage.
In that case, I'd compare and contrast it to my asset and liabilities. Is the interest rate high, are my investments low? I'd use the avalanche strategy to determine how much I'd pay.
How about a "No, I have other debts with higher interest right now" option?
Our mortgage is at 4.875% while our student loans range from 5.5% to 6.55%. We DO pay extra on those, and we will pay extra on the mortgage once those are paid off.
I have diligently adhered to Dave Ramsey's debt snowball approach for the last 3 years and have just recently come to the point where I'm able to make additional principal payments on my condo.
I'm currently paying $1700 on my $1100 mortgage and plan to do so every month (I build it into my budget) unless we have an unexpected, large expense. As soon as my wife is able to find employment (she's currently in grad school), we're going to use the majority of her income to further reduce the mortgage. It's the only way we're ever going to get out from being underwater on our condo.
I checked "Yes. I want to pay the mortgage off as fast as I can," but that isn't wholly accurate.
I plan on pre-paying a modest amount each month, but if cash flow is really tight I'll cut back to just the regular payment. On the flip side, if I have extra cash I'll put some of it towards the mortgage. The rest of the surplus gets divided up amongs the emergency fund, the fun fund, and large purchases fund. I figured this was reasonable since I am pre-paying on the mortgage but not going overboard with it by sacrificing other things.
Here's the thing: We can realistically only afford to put in an extra couple hundred if we even are able to pay extra. So while that couple hundred may not have as great of an impact when you look at a 20 year set mortgage, it would serve a greater purpose in our emergency fund so I'd say no to putting in extra. Since we're on a set plan for our mortgage just putting in that extra amount won't really do much anyway whereas if we'd built that couple extra hundred each month in an emergency fund or a high interest savings account, it'd serve us better.
Wow, I'm surprised to see that 63%, as of my vote, are paying off their mortgage as fast as they can.
I'm paying as much as I can right now, to stop paying PMI. After that, I will slow down a bit to a nice round number.