Only a small part of your mortgage payment each month pays the mortgage’s principal balance down. The rest of your payment covers the remaining parts of your mortgage payment. This includes the interest, real estate taxes, homeowner’s insurance, and mortgage insurance. What if you want to pay the principal balance down faster? Do extra principal payments actually help?
Keep reading to find out the truth about extra principal payments.
What Happens When you Pay Extra Principal on Your Mortgage?
Paying extra towards your mortgage’s principal has a direct effect on the amount of interest you pay. Your amortization schedule shows that your initial mortgage payments are interest heavy. In other words, you don’t pay much of the principal down for the first few years. Instead, your payments cover the interest for borrowing the money.
Making extra principal payments right away can knock your principal down faster. This helps cut time off your loan’s term and interest off the total amount that you pay. The extra money paid goes to the loan’s balance. This helps decrease the balance faster than if you followed the amortization schedule.
What are the Benefits of Paying Extra Principal on Your Mortgage?
You realize two main benefits with extra mortgage payments. You pay less interest and shorten the loan’s term.
Your interest is calculated based on the outstanding principal balance. Making extra payments toward the principal decreases the amount of interest paid over the life of the loan. As you continue to pay the balance down, the amount of interest owed decreases. This can save you thousands of dollars with consistent extra principal payments.
As you pay the principal balance down, the time it takes to pay the loan off in full decreases. With less money outstanding, your regular payments pay the principal down even faster. If you start making extra payments early in the loan’s term, it’s possible to knock several years off a loan’s term. This also helps build up equity in the home faster.
What are the Downsides of Paying Extra Principal on Your Mortgage?
There’s one major downside to paying extra towards your mortgage’s principal – the opportunity cost of the money you invest. If you don’t have an emergency fund set up or have retirement savings, start there first.
Once you pay money towards your mortgage, the money remains tied up in the home until you sell the home or refinance the mortgage. If you don’t have money in an emergency savings account (at least 3 to 6 months’ of expenses) or have retirement savings, you could put yourself in a financial bind tying the money up into your home.
Do Large Principal Payments Reduce Your Monthly Payments?
Large principal payments don’t change your monthly payment. Instead, as we discussed above, they reduce the time it takes to pay off your mortgage. You will reduce the loan’s term, but the payments remain the same.
For example, if your required mortgage payment according to your mortgage documents is $450 per month, and you pay $1,000 one month, you still owe $450 every month until the loan is paid in full. You can knock as much time as possible off the mortgage term, but the payments remain the same.
How Much Time Does an Extra Mortgage Payment Take Off?
The time your extra payments knock off your mortgage depend on several factors:
– When you start making the extra payments
– How often you make the extra payments
– The interest rate on the loan
– The loan’s original term
You can use an online mortgage calculator to determine how much time you’ll knock off your mortgage. Enter an estimate of the amount of the extra payments you’ll make to get a good idea. The key is making consistent payments and starting them as early as possible. As we stated above, your initial mortgage payments are interest-based. If you hit the principal early on in the loan’s term, you knock the balance down right away. This can result in less interest owed over the life of the loan and more time knocked off the term.
Does Paying an Extra $100 a Month Make a Difference?
Even though $100 doesn’t seem like much, it can knock several years off your mortgage if you pay it every month. For example, on a $200,000 loan with a 30-year term and 5% interest rate, you could knock your term down to 24 years and 9 months rather than 30 years. You would also save $37,068 in interest over the life of the loan with consistent payments.
So while that $100 doesn’t seem like much, if you start right away, it adds up. Just in the first year alone, you’ll pay an extra $1,200 toward the loan’s principal. Over the course of 20 years, you knock the principal down $20,000, which means $20,000 that you don’t pay as much interest on.
Can You Pay a 30 Year Mortgage off in 15 Years?
It is possible to pay a 30-year loan off in 15 years without refinancing. If you decide you want to be mortgage free in 15 years, use an online mortgage calculator to determine the payments you need to make. Use your current interest rate and outstanding loan balance to get your answer.
If you take the 30-year term but make larger payments, you get the benefit of being mortgage free sooner. But if you run into trouble (lose your job, get sick), you don’t have to worry about affording the higher payment. You can also jump back to the minimum 30-year payment in order to stay in good terms on your loan.
Paying extra money towards the principal can help you in many ways. Make sure you set yourself financially in other areas of your life before investing more money in your home. But once you are financially secure, making those extra payments can save you thousands of dollars over the life of the loan.