One of the biggest monthly expenditures of most families is a mortgage. For many, the minimum payment may not look that big compared to a rental. As a result, putting worries about mortgage aside quickly becomes a convenience. After all, we have many more things to be anxious about in our life including college fund, retirement, health insurance, and above all — our jobs. If we look carefully, we may notice that our mortgage does not shrink as much with the minimum payment the bank has set up for us. It is said that it is better to pay off the mortgage early. Do early payments really help?
The answer to this question is simple, although paying off early is quite troublesome. If you find that paying off early is saving you a significant amount of money, then yes — paying off early is worth the trouble. This post provides a calculator to find how much interest your mortgage will cost you during the lifetime of the loan. A calculator is provided later in this post.
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Paying off mortgage early: An example scenerio
John has a mortgage of $300K. His interest rate is 3.5%. He pays $1,400 per month as his mortgage payment (without property tax and home insurance). He will pay off his mortgage loan in 28.08 year. During this time, total interest John will pay is $171,481.49.
Jane has the same amount of mortgage with the same interest rate. She pays $1,450 per month instead of $1,400 (like John). Her mortgage will be paid off in 26.5 years. During this time, the total interest she will pay is $160,499.98.
Notice that Jane will pay $10,981.51 lesser amount of interest than John, just because she pays $50 more each month. Now imagine, how much one can save if she/he pays off $100, $150, or $200 more each month. Actually, you do not have to imagine. The calculator in this post will help you find this out.
Our mortgage calculator: Knowing how much extra we will pay
Do you know a little extra mortgage payment in the earlier years can save you tens of thousands in total, if not more? Do you know how much interest you will pay in total if you keep paying the minimum? Definitely you know — the Closing Disclosure you received from your mortgage company right before purchasing the house (before the big closing day) contained how much you would pay in total if you kept paying the minimum against your loan every month.
We have created a calculator here so that you can play with the amounts and verify how much interest you pay for your mortgage over the years. Using the calculator, you can increase the monthly payment amount and figure out how early payments may help you reduce the amount of interest. The following calculator assumes that you do not have any prepayment penalty.
Knowing if you have a prepayment penalty
Most 30-year or 15-years traditional mortgage loans in the United States do not have an early-payment penalty. Your Closing Disclosure document sent from the mortgage company should clearly state if there is any prepayment penalty. If there is a prepayment penalty, make sure that you understand how much you will lose if you pay early. I would avoid any mortgage loan that has a prepayment penalty.
Paying off your mortgage early
If you do not have any prepayment penalty, you can wake up in a fine morning and pay the entire amount of your mortgage loan. Then live happily ever after because you have saved all the interest you were going to pay in the coming decades. If paying off the entire loan is too much, you may decide to pay a little extra every month. Every extra dollar you will pay over the minimum payment will help reduce your interest. Just make sure that the extra amount you are paying every month is going toward payment of your principal loan amount.
The goal is to lower the principal early
Your goal is to reduce as much principal as you can, as early as possible. Why? Because interest is computed on the principal amount. If a large principal amount is left for a long time, you will continue to pay a large amount of interest every month.
If you checked out the Monthly Breakdown provided by the mortgage calculator above, you will notice that in earlier months you pay more interest than the principal. In later months, you pay more off principal than interest. This is because your interest is estimated against a large principal in earlier months. In later years, the principal reduces and hence the interest. With a fixed monthly payment, you pay more toward principal in later months.
A technicality of monthly payment
If you pay your mortgage online, you probably can see how much is paid off toward interest and how much is paid toward principal. If you pay an extra amount, verify if the entire extra part is going toward the principal.
Different mortgage companies have different policies for online payments. Make sure that you understand the payment policies. My mortgage company has a weird policy. If I pay the minimum payment amount ten times using ten separate transactions this month, I am basically paying for next ten due months. My next payment due date will be after ten months. Therefore, I haven’t saved even a penny. However, if I pay all the amount of ten minimum payments in one transaction, then only this month’s interest will be paid from the payment and the rest will be used to pay off the principal. My next payment due date will be just one month later.
If you pay over the phone by speaking with a representative, please explicitly mention that the extra amount is for principal payment.
A concluding remark regarding paying off mortgage early
Researching — how much mortgage interest a family is paying, how the extra interest paid could contribute to college and retirement funds, and how paying off the mortgage early could help the family in the long run — becomes the bottom-most item in the to-do list after setting up the automatic payment for a mortgage. The calculator on this page is our way of giving you a tool to aid in making informed decisions. Every family is unique. Paying off the mortgage early may work for one family while another family may benefit from investing the extra amount. At the end of the day, we do what is best for our family. We would love to hear any thoughts you have on these areas.
From a Family Blog: Settle in El Paso
