Finance, Saving Money

Shave A Year Off Your Mortgage – Just $3,600 Could Save You $8,000!

“To reach a port we must set sail –
Sail, not tie at anchor
Sail, not drift.”
― Franklin D. Roosevelt

[ Day 63 of 2000 ]

We made the decision of paying off our mortgage before we retire. We make extra payments towards our mortgage to achieve this. But is this a good move?

Strictly speaking, you are better off not paying anything more than you have to, towards your mortgage (or any other low interest loan). If you have the discipline to invest that money, that is!

Mortgage rates are usually lower than what you would make on the stock market. When you also factor in inflation, buying power of the same amount would be much less later.

However, paying off the mortgage even by a small amount is going to shave a lot of time off the entire time period. This is because of the way the loan is structured so that you make equal payments all along your loan period. Towards the beginning of your journey, this results in most of your payments just going towards the interest. The principal doesn’t come down by a lot.

When we got our mortgage three years back, we got one with a fixed rate for five years. Since we have only about two years left to get to that point, I decided to go through the mortgage documents to make sure that there is going to be no surprises later on. I noticed that the set of documents also included a few sheets of paper that had a table describing how much went towards principal and interest each month.

Case study: $205,100 loan at 3.96% interest, 30 year fixed mortgage.

I have a schedule here, for an imaginary loan of $205,100 (the median home value in the US right now, according to Zillow) at 3.96% interest rate (current rate for 30 year fixed mortgage according to mortgagecalculator.org). The loan amortization template was from Microsoft, and it came along with the installation of Microsoft Excel.

The figure above only shows the payments for the first year. If you look at the first payment (of $974.45) , only $297.62 of it goes towards the principal. And you pay $676.83 towards the interest. Suppose, at that point you could afford to pay the second month’s principal($298.61) as well. This will bring the total payment upto $1,273.06, which is the sum of  $974.45 and $298.61. By paying that extra $298.61, you would progress an extra month on your mortgage payment schedule.

On the top right corner of that table, I have the total interest and principal that you would pay in the first month. The total principal paid off is $3,637.04 and the interest is $8,056.42. If you can pay $3,637.04 ahead of time, you can save $8,056.42 over the course of the loan period. It will also cut your loan period by a year.

Your case may be different!

Of course, the exact amounts would depend on your mortgage amount, rate of interest, and how far along you are. If you are almost at the end of your mortgage period, most of your payment goes towards your principal. It won’t make a dramatic change at that point.

What did we do?

While we were buying our home, I turned to the internet to read more about mortgages. I did see several articles talking about taking a 15 year mortgage instead of a 30 year mortgage. Several others talked about making half the payments every two weeks instead of every month because there are 26 periods of two weeks each year, where as there are only 24 half months. All of that makes sense.

What I did not see anywhere was calculations that showed how contributing even small amounts could change the course of your mortgage.

We opted for a 30 year plan to keep the payments low. We wanted to make sure that we could pay them even if we lost one job, etc. Plus that brought the value of our emergency stash down. However, we made sure that there were no prepayment penalties. We have paid more than what was strictly necessary every single month so far. Some months, the extra payments are really low. Some months, they are substantial.

So if all you can afford is a 30 year mortgage, go ahead and take that. You do not have to push yourself to get a 15 year plan. You may get a lower interest rate on the 15 year mortgage. If you think that is something you can pay every month, getting a 15 year mortgage is better than the 30 year mortgage (especially if you get it at a lower interest rate). However, if it is more manageable to get at 30 year mortgage, do that. And pay off everything you can afford to. Just make sure that there is no prepayment penalty, like we did!

Limitations

The calculations here have been simplified. I do not take into account the effect of PMI if you have any. However, you would get to eliminate the PMI earlier if you do this. That will potentially save you hundreds of dollars extra. We did exactly that.

Paying the loan off early will also not get you out of the home insurance and property taxes (if they are collected together with your mortgage payment). If you are further along the mortgage, your mileage will vary. However, whatever stage you are at right now, paying off part of the principal could help you shave off days, if not months or years, of the entire mortgage period.

By the way, we are now paying towards the principal what we would have paid in 2030 had we followed their plan. We have saved a lot in interest already. If everything goes according to plan, we will have paid off the entire thing in another 1937 days. I update the remaining mortgage amount every Monday on the top right of the blog posts.

Our decision to pay off the mortgage soon was made consciously. We do want to keep our total expenses low when we retire. We see mortgage as another expense that we need to eliminate to get to our spending goal. We do not, however, use all our savings to pay our mortgage off. We systematically invest a huge chunk of our savings in VTSAX every month.

Before you make a decision to pay extra towards your mortgage, please ensure that it makes sense to you. Once that amount is paid off, you cannot get it back easily. More likely than not, the better financial decision is to invest that amount.

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About BusyMom

Mom, Software Engineer, Dreamer - Can't wait to be less busy! . Please leave me any feedback you can think of. I am still learning and anything you can tell me about making this blog better is very much appreciated. .
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15 thoughts on “Shave A Year Off Your Mortgage – Just $3,600 Could Save You $8,000!

  1. We paid extra off our mortgage in order to clear it early. Like you say, in theory it may not be the smartest move, but I’m still happy with our choice.
    Most likely I wouldn’t have invested all of the extra money that I paid of the mortgage, I’m sure some of it would have leaked away in general spending. I also like the idea that once the money is paid to the loan company, it’s difficult to get back – compared to an investment that I could liquidate to get the cash back in a moment of weakness.
    I also instinctively don’t like debt, so reducing it as quickly as possible was good for my mindset. The day I cleared the mortgage was a fantastic day 🙂

    1. Another like minded soul! I like to stay away from debt as well. In my mind, that is money I owe someone, whether or not I could make extra with it. I will be happy when I pay it off!

  2. Hey Busy Mom, We paid our mortgage off early with bi-weekly and lump sum payments. It was a guaranteed win. In theory it may not be the best financially with the way the markets have gone up but I sleep much better at night without the debt.

  3. Thanks for sharing your scenario, the example and all the different situations and factors that may apply when considering to pay more toward the principal…or investing! To match your stage in life! Congrats & stay on track!

    1. Thanks! I am glad you enjoyed it.

      Sometimes, even though you think you know something, you may not get the gravity of it until you see exact numbers. I have found that to be true many times.

      Hang on, you will get there before you expect to.

  4. We’ve decided to try and pay off a mortgage in 5 years or less and are about 11 months into that process. I looked back at our loan amortization schedule and found that we have shaved about 5.5 years off the mortgage in 11 months.

    We weren’t scheduled to reach our current principal balance until July of 2023. In addition to the time savings, we’ve also shaved about $30k off the total interest we would’ve paid.

    With this month’s regular payment we’ve just reached the point where more of our payment goes to principal than to interest and escrow.

    The decision to pay off early or not isn’t an easy one, but it’s been the right call for us given our circumstances.

    1. Hi Brian, good to have you back!

      We still haven’t reached that point. With our regular payment, it is about 40% towards principal. But we pay enough that to get 50% towards principal. At least. Our escrow is crazy.

  5. I like the idea of making small additional payments toward principal to speed up the repayment schedule. I did that early last year and it’s something I can definitely do again this year. Every little bit counts.

    1. We considered taking a 15 year mortgage. But then decided that having to pay a lesser amount every month will give us more peace of mind. We don’t have any penalties for early payment – By paying more, it doesn’t hurt us that much.

  6. Great minds really do think alike, since I posted about the same thing a day later. haha!

    http://www.dash2retire.com/2018/01/16/home-mortgage-the-great-american-rip-off/

    Of course, I wrote about how infuriating it is that virtually all interest is collected up front!

    You have a great analysis here! And as someone who has paid off the mortgage, I agree with a couple of the comments above. Once the mortgage is gone, you sleep SO MUCH better at night! Regardless of the lost opportunity cost in the market.

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