One Mortgage Payment, Huge Difference

Real Estate
on May 23, 2012

Buying a home is a big decision and one that should not be made lightly, but once you have taken the plunge and entered into a 30-year mortgage you now know how much money you have to pay for your home each and every month. When you signed the paperwork at the closing, you had to look at the amortization statement, which stated just how much money you are paying when all is said and done to own your home.

A simple way to shorten the time you are paying for your home and the amount you pay for interest is to make an additional payment every year. Instead of paying once a month for a total of 12 payments per year, you can pay half the amount of your mortgage every two weeks. Since there are 52 weeks in the year, you will end up making 26 payments, which gives you one extra payment each year that you won’t even notice missing since you’re used to paying on your mortgage every other week.

It can be a bit confusing to understand exactly why this method of making payments saves money over time. The total cost of the loan is determined before payments get made through the amortization schedule, which specifies how much money you need to pay each month. Some of that money goes towards the principal to pay down the overall balance of the loan, while the rest of it goes towards interest on how much you still owe. The amount of interest you need to pay depends on how much of an outstanding balance you have remaining each month.

The fact is that making an extra payment every year towards the principal balance has the potential to save you thousands of dollars in interest over the loan, especially if the extra payments are made at the beginning of the loan when the principal is the highest. Consider the following example. Assume you have a 30-year mortgage to purchase a home for $250,000 and your interest rate on it is 6.5%. Your monthly payments on the loan are equal to $1,580. Over the life of the loan, you will pay a total of $319,000 in interest payments alone. If you make a single extra payment each and every year, assuming it is done on the anniversary of when the loan was issued, the amount of interest you’ll pay will be reduced down to $249,000. This is equal to a savings of $70,000 and a reduction in the term from 30 years down to 24.

Another benefit of making additional payments on your mortgage is that you will build equity in your home faster than if you stuck to only making 12 payments per year. You will own your home and be free and clear with payments faster than if you adhere to the schedule first drafted by the lender. Paying off your mortgage sooner will help you on your path to financial freedom and help you become debt free that much faster. It is wise to consider the extra payments as an investment, especially since they will save you thousands of dollars in interest over the life of your mortgage.

A concern you may have concerning your mortgage is where you’re going to get the amount of money for an extra payment each and every year. If you get paid on a bi-weekly schedule and automatically put half of your mortgage payment away from that check, you’ve already established a plan for coming up with the extra payment and don’t need to do any extra budgeting. You can also make the extra payment out of a lump sum you get each year such as a bonus at work or a tax refund if you get one. There is no denying just how much money you can save by making this extra payment, so it is well worth the effort to make the attempt to find a way to do it.

If you’re still unsure about making such a large investment, plug the numbers from your own mortgage into a calculator to determine just how much money you’re paying in interest each year and to determine how much you will save by throwing a little extra towards it every year.

Found in: Real Estate
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