Thirty years -- the term of most mortgage loans -- is really a long time to pay your mortgage before you actually own your house free and clear. One way to speed up the process is to make extra principal payments on it. Since your mortgage payment, especially in the beginning, is made up of a lot of interest and a little bit of principal, sending more principal in helps to lower the amount of interest you have to pay on every other payment, freeing up more money to go to principal as time goes on.
Your mortgage's payments are set up so that if you make every payment as specified and on time, you will pay it down to a zero balance in the term of the mortgage. Paying extra will speed up the time it takes the balance to reach zero. For instance, if you have a $300,000, 30-year mortgage at a fixed rate of 4.5 percent interest and you pay an extra $126.68 every month, which is the equivalent of making an extra payment a year, you'll pay the mortgage off in 25 years and seven months.
Since you are using less of your lender's money and you keep it for a shorter time, you also pay less interest. To continue with the example, if you made 360 payments of $1,520.06 on the $300,000 30-year loan at 4.5 percent, you'd pay a total of $247,220 in interest. Paying an extra payment every year cuts your interest expenditure down to $205,678 -- saving you more than $40,000. If you could pay an extra $250 a month, you'd pay your loan off in just under 23 years and pay $177,358 in interest -- saving nearly $70,000 over the life of the loan.
Forced Savings Plan
One of the intangible benefits of paying your house down more quickly is that it's an excellent way to save money. Sending extra principal to your mortgage stores money in your house where you're less likely to tap into it. Although your house doesn't pay you interest like a savings account would, paying your mortgage down saves you from paying interest. Since your mortgage's interest rate is probably much higher than your savings account's rate, you come out ahead.
If you're serious about making extra principal payments, consider taking out a shorter term mortgage. Shorter-term loans have higher payments, but they pay off more quickly. Since the bank knows they're going to get their money back sooner, they usually charge a lower rate. It's not uncommon for a 15-year mortgage's interest rate to be 25 percent less than a 30-year's.
For example, if you could pay $300 extra a month, you could refinance the $300,000 30-year mortgage at 4.5 percent to a 20-year loan at 4 percent. The payment would be $1,818 a month, but you'd only pay $136,306 in interest over the life of the loan. To pay off the original $300,000 loan at the higher 4.5 percent rate in 20 years, you'd have to pay $1,898 a month and end up paying $155,507 in interest.
- Bankrate.com: Bankrate.com Averages
- Bankrate.com: Making Additional Principal Payments
- American Financing. "Should You Make Extra Mortgage Principal Payments?" Accessed March 17, 2020.
- Debt.org. "How to Pay Off a 30-Year Mortgage in 15 Years: Tips & Tricks." Accessed March 17, 2020.
- Nationwide Mutual Insurance Company. "6 Ways to Pay Off Your Mortgage Early." Accessed March 17, 2020.
- Consumer Financial Protection Bureau. "How Does Paying Down a Mortgage Work?" Accessed March 17, 2020.
- Consumer Financial Protection Bureau. "What Is a Prepayment Penalty?" Accessed March 17, 2020.
Steve Lander has been a writer since 1996, with experience in the fields of financial services, real estate and technology. His work has appeared in trade publications such as the "Minnesota Real Estate Journal" and "Minnesota Multi-Housing Association Advocate." Lander holds a Bachelor of Arts in political science from Columbia University.