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Double down on your mortgage - it&amp;amp;amp;amp;#039;s cheaper than you think

Everyone knows that carrying a mortage for 20-30 years will result in a lot of interest payments, and paying more will accelerate the process. But how much more should you pay? What will be the impact?

I recently saw a graphic showing the exact interest and principal payments over the life a mortgage and noticed that in the first years the interest can account for shockingly high amounts of the payment - sometimes over 90%! Naturally I started to wonder if there’s a better way - if you’re barely paying any principal, it should be easy to double it. Read on to see the results…

After some experimentation I came up with an excel spreadsheet illustrating the life of a 30 year mortgage with 6.5% interest. If you borrow $150K, the monthly payment is around $950. It turns out that 14% of the first minimum payment would go to the loan itself, and the rest would go to interest. As expected, the calculations show that the balance after 30 years of this is $0. But 30 years is a long time…

I set up a table side-by-side that shows what would happen if you double the principal payment, with a maximum of $300 more per month. The first month pays about $145 for the principal, so instead of paying $950 you pay $1100 (rounded), and so on. In the first year, if you keep doing this and pay an extra 16% every month, you’re actually paying off 207% of what you would with minimum payments!

For the first few years you’re moving twice as fast: doing this for one year leaves you at the same place as 2 years of minium payments, and so on. This slows down later in the life of the mortgage, but after 18 and a half years it’s done - in fact, if you continued to make these payments and earning (instead of paying) the interest for the rest of the 30 years, you would have a house and $250K.

That sounds great, but what’s the cost? Starting with a payment of $1100 rather than $950 in the first month instead of $950, you move up to $1257 per month over 13 years - that’s enough time for most people to get a raise of $150 per month ($3000 per year). It’s true that if $950/month is stretching your budget you’ll find it difficult to add more, but cutting back on other things a little can let you own your house a full 12 years earlier, after paying approximately $130K less - if this is your first home, that’s enough of a bonus to help you move up much earlier.

Many people spend enough on things they won’t remember a week later that they wouldn’t miss $100 or $200 a month (or more for a larger mortgage). Another way to look at this is that you start out losing $800/month just to get in the game - after that, why would you only want to pay $150/month for the loan itself? It’s like getting in to the Olympics and sleeping through your race! (ok, that’s a bit over-dramatic)

One problem with this is that some mortgages limit your ability to go above the minimum payments - for example, you might be able to pay up to 15% more per month and make a lump-sum payment of up to 15% of the value of the mortgage in one year. The bank sees it as a commitment to pay them lots of interest (which is bad for you) and they don’t want you getting out of it. In that case, the best thing to do is to add to the monthly payments until you hit the maximum, and then automatically transfer the remaining amount to a savings or money market account for a yearly lump sum payment. Since the interest you get on the savings will be less than the mortgage interest it goes a bit slower, but you can still save time. If you actually max out the monthly payments and yearly lump sum payments your mortgage won’t even last 6 years!

How is this different from just getting a shorter mortgage? If you got a mortgage with payments over 18 years instead of 30 the principal balances would be similar, with fixed monthly payments of $1180. A 15 year mortgage would have payments of $1300. Which way is better for you depends on how hard it is to force yourself to make extra payments and how much flexibility you need - but the important thing is that you can save years for a relatively small increase in your payments.

Download this excel file and try it out with your own numbers to see what’s possible for you: mortgage example.

This entry was posted on Monday, November 26th, 2007 at 12:16 pm and is filed under Site. You can follow any responses to this entry through the RSS 2.0 feed. Both comments and pings are currently closed.

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Double down on your mortgage - it&amp;amp;amp;amp;amp;#039;s cheaper than you think

Double down on your mortgage - it&amp;amp;amp;#039;s cheaper than you think