It’s an incredible feeling to walk through your front door each and every day, knowing that this house is yours — and yours alone. No one else can take it from you or make any decisions regarding it…as long as you don’t count the lender who holds your mortgage. For many people, knowing that they’ve got tens or hundreds of thousands of dollars worth of debt hanging over their heads is enough to ensure some pretty sleepless nights.
Rest tight tonight, we’re going to help you develop a plan for paying off your mortgage early in the simplest way possible — by making more payments. Oh, I can hear you already, crowing that you can barely affording the mortgage payment you’ve got and insisting that you simply can’t make more payments. Trust me, we’ll make it as painless as paying off a mortgage can be.
The Parts of Your Payment
Just as a review, let’s go over the parts of your mortgage, after all, it’s not all just the part we call the “payment.” Your mortgage is made up of several small payments, including a portion of your loan principal, mortgage interest, mortgage insurance, property taxes and mortgage insurance when applicable. These parts combine to form what we properly call your mortgage payment, even though it’s a lot more than that.
Year after year, if you pay your payments on time and nothing drastically raises your taxes or insurance, your payment stays basically the same, but the principal you’re paying increases. For example, if you’ve just closed a $200,000, 30 year fixed rate mortgage at 4.00 percent interest, the principal and interest portion of the payment will total $954.83, but only $288.16 of that is actually helping to knock down your giant mortgage balance. If you make all your payments on time, just five years later your principal portion of that same $954.83 P&I payment is up to $351.85 and the interest is down to $602.98.
And so it goes, until you’re finally paying more principal than interest in each payment and your mortgage magically starts to shrink right before your eyes. Unfortunately, that point is roughly 20 years into your mortgage! Because of the way mortgages are structured, you pay more of the interest up front and more principal toward the end of your loan, which makes it hard to get out from under other payment-bulking items like mortgage insurance. Maybe paying a little extra isn’t such a bad idea after all.
Principal and interest parts of mortgage payment on $200,000 30-year fixed rate loan with 4.00% interest rate
Just One Extra Payment a Year…
I’m sure you heard it at closing and you were probably had a pretty healthy amount of skepticism then, too, but just one extra payment a year can actually cut a significant chunk of time off of your mortgage. Since you’ve not got a prepayment penalty, it doesn’t cost you anything extra to pay a little more, so if you’ve made the decision to pay your mortgage down as fast as you can, an extra payment is the best place to start.
The problem with mortgage lenders saying things like just one extra payment is that they tend to forget we’re still sort of puttering around trying to decide if we’re still functionally in a recession. Your dollar isn’t going very far, the cost of food is still high after two years of crop failure back in the early 2010s (in case you were wondering, those crops were hay and corn, respectively) and you don’t forsee a raise in the near future since half your department is still laid off. Coming up with another $954.83 and then some (depending on your taxes, insurance and mortgage insurance) in one big lump isn’t happening. Not even a little.
Maybe you’re like most of us and you can’t scrape that kind of dough together, but I’d bet you could find $20 a week, or just $4 every weekday. Seriously, what do you want more: a frothy, calorie-filled cup of creamy, delicious Starbucks coffee with extra whipped cream and a drizzle of liquid chocolate or to pay your mortgage off early? OK, that was a little unfair — Starbucks is hard to compete with, but you get my point. Start brown bagging it, cook at home more, see fewer movies at the theater — find that $20!
Whether you choose to save that extra $954.83 and pay it all in one lump or pay 1/12 of it each month is up to you, but there will be a small savings from interest and mortgage insurance if you pay an extra $79.57 every month as opposed to the full $954.83 at the end of the year. Either way you go, you’re paying off your home and gaining equity much faster than planned, and that’s a great thing!
Let me show you what you’re going to get for a little less than $20 a week if you add 1/12 of your payment to your principal and you can decide for yourself if you’d rather start watching those cinema blockbusters at home on your Roku. This is going to require another one of those nifty charts. We’re still just playing with the principal and interest payments for the sake of simplicity, so bear that in mind.
Effects of an extra $79.57 principal payment on a $200,000 30-year fixed rate loan with 4.00% interest rate
No, your eyes do not deceive you. Less than $20 a week can turn into under $5,000 worth of extra equity in just five years, and just over $11,000 in ten years. This is just a basic calculation, too — if you’ve got mortgage insurance, that figure is also going to drop like a stone as your equity increases. And you can do this — you’ve got it under control, I’m sure of it. Just $20 a week, remember? It’s not worth much these days and you’ll sleep better knowing your home is on the fast track to payoff. At that rate, your home will be your own in just under 26 years
Setting Up Bi-Weekly Payments With Your Bank
For some people, especially those who are paid every two weeks or twice monthly, the bi-weekly payment can help keep them on track toward their goal of paying down their mortgage faster.
Basically, how this works is that your bank takes your same monthly payments and cuts it up into two so that you have a smaller payment due every two weeks. Instead of $954.83, your principal and interest payment would be closer to $477, but due every two weeks instead of the first of each month. With bi-weekly payments, you end up making 26 (not 24) ‘half payments’ instead of 12 monthly ‘full payments’ at the end of each year. If you can commit to the payment each fortnight, you will have paid down about the same amount of principal at the end of the year as you would have if you made a single yearly extra payment.
Bi-weekly payments aren’t for everybody, so make sure you can commit to two smaller mortgage payments every 2 weeks before you call your bank to set it up. Just like a monthly mortgage payment, it’s a big deal to miss your bi-weekly mortgage payment and you’ll rack up penalties and extra fees, too.
Paying Extra Principal on Tighter Budgets
A few of you, maybe more than a few, may be working with much tighter budgets that don’t allow for a Frappacino every day during the workweek. Just because you don’t have a place to readily find that weekly $20 we were talking about doesn’t mean you can’t pay any extra on your mortgage, though. If you check your monthly payment stub, or look at your account online, you’ll see that you’ve always got the option to pay extra principal on your mortgage. What you have to add may not be a lot, but every little bit chips away at your obligation.
Let’s say you just round your $954.83 payment up every month by adding a wee $5.17 to make a grand total payment of $960. You probably can swing that $5.16, and believe it or not, it will matter. Let me show you just how much.
Effects of rounding up payment by $5.16 on a $200,000 30-year fixed rate loan with 4.00% interest rate
By simply adding an extra $5.16 to your principal payment each and every month, you’ve shaved three months off your loan. Well, that’s just incredible! Five measly bucks that won’t hardly even buy enough gas to get across town just made you mortgage-free 90 days sooner! Just for fun, let’s see what would happen if you rounded your payment up to $1,000. That’s $45.16 each month, still a lot less than $20 a week.
Effects of rounding up payment $45.16 on a $200,000 30-year fixed rate loan with 4.00% interest rate
Forty dollars extra each month can make a big difference, you’ll even have this note paid off about 27 1/2 years into it, saving a whopping 2 1/2 years of payments!
Extra Principal Payments Side-by-Side
As I’ve shown you, there are lots of ways to pay extra principal without even trying. You can make an yearly extra payment, choose bi-weekly payments or even simply add a little every month to the principal you owe. If you really need to get your mortgage paid down, mix it up and pay as much extra each month as is possible. In case you’re still weighing your options, I summarized the high points from above into this chart, just to make it all a little easier.
|Year||No Extra||Extra $5.16 Monthly||Extra $45.16 Monthly||Yearly Extra Payment|
Remaining principal on $200,000 mortgage with 4.0% interest rate after set number of years
Of course, this is just an example of a mortgage, if your home’s price is considerably more or less than average, you’ll have to do some of your own calculations. Our own web-based mortgage calculator can help you determine the effect of different extra payments on your mortgage or, if you need to calculate mortgages on the go, you can check out our mobile app.
The Bottom Line: Starbucks or Your Home’s Deed?
I know, I know, this Starbucks stuff is getting old, but paying off your mortgage early really is that simple. Although paying a mortgage off early isn’t the right choice for everybody, if you need to get some equity fast (relatively speaking, that is), there’s no better way to do it than to simply cut your expenses and find the money. Cut coupons, go meatless three nights a week, whatever it takes.
Years ago we’d have talked about the sick amount of interest you’d be saving in those missing years, but honestly, interest rates are so low right now that they shouldn’t be a primary motivator. Instead, paying down a mortgage in 2014 is about being able to afford your home well into an unstable future, building equity when home values are still unsteady and knowing you’ll always have a roof over your head.
If it’s right for you, do it. Start today and don’t look back. With every month, it’ll get a little easier until suddenly your mortgage is paid in full. Have a mortgage burning party while you’re at it — why not, you earned it!