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How to Reduce Your Mortgage
One Additional Mortgage Payment a Year
There's a simple trick to significantly reduce the length of your mortgage and save you thousands of dollars. The trick is to make one extra mortgage payment a year and apply that payment toward your loan's principal.
This is the method being used by "Bi-Weekly Mortgage Reduction Services" and "Bi-Weekly Mortgage Savings Programs". Only, when you do it yourself, you don't pay a third party unnecessary set-up costs and fees!
Example: $100,000 loan, 30-year mortgage, 6.5% fixed interest rate
|
Extra Mortgage Payments/ Year |
Principal & Interest |
Additional Monthly Payment |
SAVINGS |
Total Paid |
# of Years |
|
0 |
$632.07 |
0 |
0 |
$227,542.98 |
29.92 / 359 mos. |
|
1 |
$632.07 |
$52.68 |
$29,088.02 |
$198,454.96 |
24.12 / 290 mos. |
|
2 |
$632.07 |
$105.35 |
$28,399.71 |
$181,050.85 |
20.5 /
246 mos. |
|
3 |
$632.07 |
$158.02 |
$58,320.95 |
$169,222.03 |
17.92 / 215 mos. |
|
4 |
$632.07 |
$210.69 |
$66,969.79 |
$160,573.19 |
15.92 / 191 mos. |
|
5 |
$632.07 |
$263.36 |
$73,607.77 |
$153,935.21 |
14.34 / 172 mos. | |
One-time Payment
It may not be possible for you to increase your monthly mortgage payment. Keep in mind that most mortgages will permit you to make additional payments to your principal at anytime. Perhaps, five-years after moving into your home you receive a larger than expected tax return, or an inheritance or a non-taxable cash gift. You could apply this money toward your loan's principal, resulting in significant savings and a shorter loan period.
Example:
With a $100,000, 30-year, 6.5% fixed interest rate mortgage loan, the borrower will pay a total of $227,542.98 to pay back the loan in 30 years. That equals $127,542.98 in interest payments.
If the same borrower makes a one-time $5,000 payment the first day of year 6, he/she will pay a total of $204,710.75 and pay off the loan in 27 years (324 months). That's a savings of $22,832.23 in interest.
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All the above is good and correct, but I would like to present to you another way of saving money, for you to decide of the best way to choose...
Some people who pay down their mortgages early may be better off putting that money into a tax-deferred retirement plan, such as a 401(k). Here’s a simple formula to figure out which option makes the most sense for you from a wealth-building perspective:
1. Take your mortgage rate, and subtract your interest expense deduction (your tax bracket multiplied by the mortgage rate) to get the after-tax cost of your mortgage.
2. Look at the rate of return of a conservative investment in your 401(k), such as a government bond fund. Subtract the after-tax cost of your mortgage.
Example: Bill has a 30-year mortgage at 6%, and he is in the 25% income tax bracket.
1. 6% - (6% x .25) = 4.5%
2. Bill can invest in a conservative bond fund in his 401(k) that yields 5.5%. He effectively earns 1% more on his money by putting it into the 401(k) versus an extra mortgage payment. (5.5% – 4.5% = 1%).
More importantly, if Bill’s employer offers a match on 401(k) contributions, it’s a no-brainer to put the money in the 401(k).
I used to make an extra mortgage payment every year, but switched to investing the money when yields on conservative investments started to rise. For some folks though, this is not a mathematical issue but one of security — they just want that mortgage paid off. For people who are very debt-averse, the peace of mind of paying off the house more quickly is worth the price.
As I've mentioned before, it is your way and your choice to decide either to save on the mortgage or to invest with government bond funds, or other methoods of savings.
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