Home mortgage payments get made every month, for up to 360 months if you stay in your home that long and don't refinance. Your home mortgage is also likely your largest monthly expense, so hopefully you're interested in tips to save on your home mortgage?
First let's look at what you're paying with your home mortgage. You can do this easily by pulling out a statement which should show your account activity. The largest amount will be interest, until you're close to paying off your home mortgage. The smaller amount is principal, i.e. how much of your monthly home mortgage payment goes to reduce the loan amount. Hopefully you're also paying taxes and insurance in escrow but we'll leave that for another article.
Reduce Your Home Mortgage by Paying More?
You might be wondering how you can reduce your home mortgage by paying more? It works but it takes some digging to understand why it works. Let's start by illustrating the basic concepts of borrowing and repaying principal plus interest. The loan amount for a home mortgage is called the principal and each month, a small portion of your mortgage payment is applied to your principal until it's zero. At the beginning of your loan, most of your monthly home mortgage payment goes to interest, i.e. interest can be more than 80% of your payment.
When you include more than your minimum monthly home mortgage payment, the extra money lowers the outstanding loan amount or principal. By lowering the principal faster, you will pay less interest over the life of the loan. Let's use a really simple example where you borrow $100 and agree to pay $10 each year for 10 years. You also agree to pay $1 each year for every $10 you owe, i.e. after 1 year you would pay $10 principal reduction plus $10 interest as you owed $100.
The real story here is when you pay $20 each year, you will cut your interest payments by $25 or almost half ($55 for 10 years or $30 interest in 5 years). You can also pay off the loan in 5 years versus the original 10 year loan period. Maybe one year you can't afford to make the larger payment? With the 10 year loan, you can adjust the payment down to the minimum which is why it's smart to get a 30 year home mortgage, but pay it off faster to save interest costs.
Home Mortgage Calculators
The example above is simple to illustrate the savings possible with your home mortgage. The calculations are much more complicated that shown here, so it's best to use one of the online mortgage calculators to help you decide how much you want to pay monthly. To get started, let's use a $200,000 home with a mortgage of $160,000 and an interest of 4$.
With a monthly payment of $763.87, you can round up $6.13 per month and pay off your home mortgage 5 months early. Increase your savings by bumping your monthly payment to $800 per month to shorten the life of your mortgage by another 24 months. Don't hold your breadth yet – round up to $1,000 per month and your 30 year mortgage will now be paid off in less than 20 years, wow!
What's really exciting about this opportunity is you can get the savings but keep the flexibility of a 30 year mortgage. You might save a bit more with a 15 year loan because it will have a slightly lower interest rate, but you can't lower the minimum payment of a home mortgage so once you commit to the higher 15 year payment, you're stuck for the life of the loan. Chances are that if/when you need to reduce your monthly home mortgage expense, you won't be able to refinance to lower the rates. Even if you can refinance, it will take several months and cost out-of-pocket dollars which will likely eliminate any savings you might have received from the initial 15 year rate.
There are many home mortgage calculators like DecisionAide.com, which I used to create the charts above. To find a calculator that will let you experiment with savings from pre-paying your home mortgage, google “mortgage calculator prepayment savings”.