Even a small amount ($25, $50, $100) added to your mortgage payment each month when applied to the principal can have a significant impact on the total amount of interest you pay as well as how long you pay it.
For example, if you divide your monthly mortgage payment by 12 and add that amount to your monthly payment each month by the end of the year you will have paid the equivalent of an extra mortgage payment for the year—a 13th payment—all invested in principal reduction!
That 13th payment can make a big difference. For example, let’s say you borrowed $200,000 at 6.5 percent interest with a 30 year term. Your monthly payment would be a shade over $1,264 a month for principal and interest. By adding an extra $100 per month ($1,200 per year) you would pay off your mortgage in just over 23 years, knocking almost seven years off the loan and saving over $73,000 in interest.
Contact your lender to find out how they apply extra payment money from you. Some lenders may apply your extra money that you pay above your monthly payment amount automatically to your principal.
However some may appy it to your escrow account to pay taxes or insurance which is NOT what you want them to do! Make sure you read the fine print, and call (or write) your lender to confirm what they will do, or how you can assure that the extra money goes to reducing your principal balance.
Tip: Sending a separate check and clearly marking the “memo” field with your loan account and the phrase, “Apply to Principal”will help assure proper credit and provide strong documentation of your extra payments. Again, check with your lender.
Tip: Don’t bother with offers from your lender or 3rd party companies that offer to charge you money (often as much as $200-$300) to set up a bi-weekly payment program—you can accomplish the same thing yourself without their help—for free.
IMPORTANT NOTE: Although this is a great strategy to accomplish the twin goals of saving money and increasing equity in the capital asset that is your home, this may not be the best use of your financial resources.
Interest rates for home mortgages tend to be lower than most other consumer loans and your financial profile may suggest a better use for this money—like paying off higher interest consumer loans first.
Anytime you pre-pay extra money on any installment loan it has the same effect as investing your money at that interest rate. So if you had an extra $100 should you pre-pay it on a home loan at 6.5% or a consumer loan at 10%, for example? And don’t forget that mortgage interest is usually fully tax deductable, whereas other consumer interest is not.
Therefore, we recommend consulting a qualified financial advisor for a proper evaluation of your total financial picture before proceeding with this strategy.