Mortgages can be viewed very differently.
Some see them as a positive financial instrument, a way to free up their money so it can be invested elsewhere, ideally for a better return.
Then there are those who view mortgages as the root of all evil, as a debt overhang that must be terminated as quickly as possible.
Whatever your stance, you’ve probably entertained the idea of making “extra mortgage payments,” though you may not know the exact impact, due to the complexity of mortgage amortization.
Fortunately, there are calculators available that take the guesswork out of the process and make it easy to see how much you can save in a number of different scenarios.
Adding $10 a Month
Let’s start with a simple scenario where you add just $10 a month in extra payment to principal.
Assuming you’ve got a $100,000 loan amount set at 4% on a 30-year fixed mortgage, that extra $10 payment would save you $3,191.78 over the full loan term.
It would also shorten your mortgage by 13 months, meaning your 30-year mortgage would be a 28-year (ish) mortgage.
So that’s good news, right? You save thousands and you only have to pay a measly $10 extra per month. You probably wouldn’t even notice the difference.
What if you bumped up that extra payment to $25? Well, you would shave 32 months off your mortgage, nearly three years, and reduce total interest by $7,450.01.
Feeling ambitious? Add $100 a month and you reduce your term by 101 months, or nearly 8.5 years, while saving $22,463.76 in interest.
[30-year vs. 15-year mortgage]
Extra Payments More Valuable Early On
As you can see, it’s not that hard to save a ton of money via extra payments, but it also matters when you start making those additional payments.
Using our $100 example, if you started making extra payments in year six of your 30-year mortgage, (month 61) you’d only save $15,095.22, and shed just 78 months off your mortgage.
Even if you decided after just one year to make the extra $100 payment, your total savings drop to $20,989.52, and 96 months come off your mortgage term.
In short, the earlier you start making extra payments, the more you’ll save. This is mainly becausemortgage payments are interest-heavy in the beginning of the term.
[Are biweekly payments a good idea?]
One Extra Lump Sum Payment
Now let’s assume that you came upon some extra dough and want to make one lump sum payment to reduce your mortgage balance.
Using our same loan details from above, if you made a one-time payment of $5,000 to principal in month 13, you’d save $10,071.64 and reduce your loan term by 31 months.
If you made that same $5,000 payment at the beginning of year six of the mortgage, the savings drop to $7,944.04 and the term is only reduced by 27 months.
You could also make one extra lump sum payment at the beginning of each year, perhaps after receiving your year-end bonus.
So let’s say you make a $1,000 bonus payment each year in January, starting in month 13.
That would save you $19,005.19 in interest and shave 85 months (about 7 years) off your loan term.
As you can see, there are all types of scenarios that abound here, and which one you choose, if any, is up to you.
You might argue that mortgage rates are super cheap, and thus determine that making extra payments now makes little financial sense.
Or you could be living in your dream home and not too far from retirement, with the hopes of living “free and clear” sooner rather than later. If that’s the case, making the extra payments now may be very appealing. Refinancing to a shorter term could also make a lot of sense.
The changes coming to the mortgage interest deduction could also come into play, so be sure to watch news on that front as well.
And know that plans (always) change; homeowners are much more likely to move or refinance their loans as opposed to carrying them out to term.
Please follow Your Money on Twitter and Facebook.