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.