Hello best life seekers!
If you’re a homeowner with a mortgage, your biggest money sink is the monthly interest you pay on your loan, especially if you’ve had the loan less than 15 years. Want to learn a payment hack that will save you tens of thousands on your mortgage interest and also drastically cut your number of mortgage payments? With $2500 you can literally save $9,000 in interest. And you can do this multiple times. Anyone who has a mortgage or is getting one needs to know this. Most homeowners don’t take advantage of this cheat and it literally costs them tens of thousands of dollars. It’s an extra payments trick and let me show you how it works and how best to use it.
The True Costs of Buying a House
The average cost of an existing home sold in May this year was $264,800. But wait, that’s just the sticker price. If you get the typical 30 year mortgage, with 20% down at 5% fixed interest you’ll pay an estimated $1420.54 a month (principal, taxes, and interest) but at the end of your 30 years and 360 payments, you’ll have paid $511,393.05. And that’s assuming your taxes and insurance never rise. Yeah right. Good luck with that!
This is the mortgage breakdown for that average $264,800 house.
As you can see, the sale price of your house is highly misleading, and this more revealing chart doesn’t even take into account closing costs, repairs, maintenance, upgrades, etc. over those 30 years. It also assumes 20% down. If you put down less and have PMI, you’ll pay a lot more in interest over that same 30 years.
Is Monthly Interest Eating Your Paycheck?
These figures are for the average existing home sale at average mortgage rates. Notice that after 30 years, you will have paid $197,553.05 in interest alone. For the first year of payments, your monthly interest will average $876 in interest but a measly $260 in actual principal, meaning that after a year you will have paid $10,521.02 in interest but only $3,125.41 toward your actual loan balance.
Only after 15 years of payments will your interest and principal amounts equal each other. So if you buy a house and close January 1, 2019, you won’t see the payments equalize until 2035 at roughly $568 a month each.
You’ll also have paid around $160,000 in interest during those 15 years. Take a look at the amounts paid your first 15 years in the chart below.
And you’ll still owe $136,065.64 on your loan and have 15 more years of interest payments to boot! That’s a hell of a lot of interest and it adds up to $197,533.05 over the life of your loan. Does this seem like highway robbery to you? It does to me.
Want to Save $10,000 or $50,000 or More?
Here’s what I do on my mortgage and what you can do to cut down your mortgage interest by tens of thousands of dollars while simultaneously cutting down your number of mortgage payments by the dozens with a simple extra payment of $2500. That might seem like a lot for an extra payment but it has outsized rewards. If you’re living the 70/30 Rule then you have 30% of your net income to invest in money-making or debt payoff options. Here’s how a one time extra payment of $2500 early in the mortgage pays off big time, let alone done each year.
In our average example, if you make an extra payment of $2500, your principal balance drops from $211,585.46 to $209,085, which recalibrates your interest and principal now due. At the same time you have eliminated 10 months of payments from your entire loan for an interest savings of just under $9000 (see chart below)
If you have a $160,000 mortgage, that same $2500 will actually take out an entire year’s worth of payments and save you $8000 in interest.
Do this $2500 payment a year and you will literally save yourself tens of thousands of dollars in interest over the life of your loan. Saving $9000 on $2500 that earns you equity is a fantastic return on investment. If you’re not sure where to invest some of your 30% in net income, look here. You’re really not going to get a better return on your money anywhere else. Best of all, you’re not going to get taxed on this “windfall” either. Win-win.
More Bang For Your Buck – Timing
In the first 15 years of your loan, you payments mostly go toward paying down accruing interest rather than principal. Eventually this flips and by the end you’re mostly paying down principal. This makes sense when your realize you have more outstanding debt that’s accruing interest at 5% a year at the beginning of your loan than at the end. Early on though your interest payment is 3 times principal for your first 5 years (see chart below). Ouch.
This also means you’ll get more mileage out of extra payments early on compared to that same payment 15 years or more later. By paying early, you’ll instantly drop your outstanding balance, which drops the interest that can accrue over the life of your loan.
Look at the difference in interest in the first 10 years versus the last 10 years of our typical 30 year loan (chart below).
If 10 years still remain on your loan, you’re definitely accruing a large amount of interest, somewhere around $480 a month at the beginning of year 20, even if your principal amount now has correspondingly grown to $657. Any extra payment is helpful and definitely make them. An extra $2500 payment in year 20, however, will only knock off roughly $1880 in total interest and subtract 4 payments from your total loan life. That same $2500 in year 1, though, will knock out roughly $8800 in interest and decrease your loan payments by 10. That’s quite a difference and it’s really impressive if done over the life of your mortgage.
Amortization is a Big Word
By making a few extra lump sum payments you will save yourself tens of thousands over the course of your loan. To personalize your own return, get familiar with amortization tables. Amortization just means how your loan breaks down over the course of your total payments. I freaking love these tables! They lay out monthly and yearly interest and principle amounts. You received one with your loan documentation.
Whether you do or don’t know where yours is, you can run one quickly and freely via Mortgage Calculator – Amortization by typing in your loan amount, interest rate and down payment figures. The website will generate the rest. You can also get your bank to send you one electronically or in hard copy that you can more easily match to your current payment schedule. Mortgage Calculator is generic in its dates but the monetary figures should match your bank’s.
These tables show you where your monthly payments for principal and interest really go. For those who haven’t looked at them, these can be horribly shocking. Your numbers are in black and white. Remember though, HOA and insurance aren’t included. This is strictly money paid to the bank, not to escrow or other extraneous places, for the loan portion of your mortgage.
Banks count on you never looking at these and getting uncomfortable with how much money they take from you in interest. Nor do they want you to see how extra principal payments actually benefit you when you do the math for yourself.
If you’re like “I hate numbers” and “I hate 4th grade math”, then fine, fork over almost $9000 a year on your average home loan instead of using it elsewhere. I don’t know about you but I have a lot of uses for that kind of money. I’ll happily do the math to see what will knock off a year’s worth of payments, net me equity, and eliminate $9000 of interest at the same time.
Unless you’re in the last few years of your loan, any payment of $2500 in a year will save you considerable interest. Do that every year for the life of your loan and you’ll be paid off far sooner than 30 years and will have paid a boat load less in interest, meaning you’ll have that difference in purchasing power. It may not seem like money in your pocket but it is because you originally scheduled to pay that interest and now don’t have to.
That’s found money to me.
Additionally, should you run into financial problems down the road, you can recast your loan and drop your monthly payments for like $100-$200. Since you are recasting and not refinancing, your interest rate won’t change even if by then refinance rates have tripled. Wait, what? How?
It’s called recasting your loan. When you make extra payments, you can either have those payments put off your next payment date or just be extra. Make sure they aren’t postponing your payment date. Sometimes sneaky banks will try to use that extra payment as payment toward your next amount due – that way they can keep accruing interest on you. Don’t let them! Make sure it’s going only to principal and doesn’t affect your monthly payment dates and amounts.
When you do this, you’re paying down principal rapidly but your monthly loan payments continue and follow their normally scheduled dates and amounts. In our example, that monthly payment is $1420.54 (of which $1137.20 goes to the bank and the rest to escrow). However, extra payments knock out interest and principal. If you do $2500 for four years, you’ll see your recast loan payment now around $1116 a month. That $20 a month difference may not seem like much, but that’s $240 a year over now 26 years (no longer 30 years) for $7,200 less paid than if you didn’t recast.
If you make larger extra payments or continue them over the life of your loan, you’ll see even bigger differences in your new loan payment amount should for whatever reason you need to recast your loan for lower payments. Recasting is just another side benefit that helps you financially should you run into money problems. But only if you’ve made extra principal payments. That’s nice insurance and typically costs only $100-$200 for the bank to update your loan.
Money Kept In Your Pocket
As little as $2500 a year extra on your loan comes with big rewards. Making extra principal payments can:
- Drastically shorten the life of your loan
- Return money to your pocket otherwise scheduled to an already fat cat bank
- Build equity quicker in your house
- Save you from being taxed on the return on your investment
- Give you sounder financial health
- If you hit a financial snag, you can recast your loan to lower your monthly payments
This is all a win for you and means more money in your pocket to use in better ways. Seriously, $2500 can save you practically $9000 at current interest rates. Use that $9000 on something else. Make that extra payment every year for even more savings and spending power over the life of your loan. You can also break up that $2500 over the year but a lump sum saves roughly $125 lost in interest via installments over that same year. Either way, make the extra payment because you’ll come out way ahead in the long-term.
Another fun thing about this? It works on student loans just the same way. Or any loan really. The higher the interest rate you’re charged, the more money you’ll recoup from extra payments.
Get out from under your debt, keep more money in your pocket in the long run, and stop throwing your money at already greedy banks.
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