The following is a guest post about extra payment on your mortgage. If interested in submitting a guest post, please read my guest post policy and then contact me.
A mortgage has to be one of the most important loans a person will take in their life time. Year after year, people strive to attain that coveted title – Homeowner. The process alone can be grueling since it involves a lot of documentation and verifications. For as long as I can remember, I’ve always heard that if you made an extra payment on a 30 year mortgage, you will be saving 7 years. This means on a 15 year mortgage, you should save about half (3.5 years) right?
There are 3rd party companies who send out solicitation letters advising recipients to set up biweekly mortgage payments for a fee. Hint: By making biweekly payments, you will make an extra payment because the payments are taken every 14 days. (If you work a regular 9-5 and get paid biweekly, you know how there are 2 months in the year you get paid 3 times. Yeah just like that and oh yeah I look at my calendar). The solicitation letters can be pretty convincing showing savings in dollars (of course they know they have to show you the money). Their selling point, “making an extra payment will shave off 7 years on a 30 year mortgage”. They typically get older people to sign up.
First off, if you receive this solicitation letter from a 3rd party company, contact your own bank i.e the one you make payments directly to and ask to be set up. Also you shouldn’t be paying a fee. If they (even your own bank) insist on collecting a fee, don’t bother signing up. With a little discipline, you can actually do this on your own.
Does it Make Financial Sense For You to Pay Extra?
After working in banking for about 7 years and understanding how loans work, I began to doubt that statement so I decided to run the numbers for myself. It turns out that’s it not true. Maybe this is a white lie spun by those 3rd party companies who just want you to make your mortgage payment quicker or collect a fee for setting you up for biweekly payments.
If your sole desire is to pay off your mortgage early, you would have to be aggressive. Aggressive means more than just making an extra payment once a year. The interest on a mortgage accrues daily. Well, all loans do. A mortgage payment calculation is designed in a way that the bank gets their monies back in the first half. Notice in an amortization schedule of a 30 year loan, it’s not until at least your 10th year (depending on other factors) you actually start hitting the principal. The bank understands more than anyone else that 30 years is a longggggg time. Here’s what I found out. Making an extra payment on a 30 year mortgage will only save you 1.5 years and in some cases, just a little bit more but not up to 2 years. This means that on a 15 year mortgage you’re only looking to save roughly about 6-7 months.
So I began to wonder how can one save a significant amount of time on their mortgage? I spent some more time with my trustworthy calculators and found out that if you paid your exact principal from the first day you start making payments towards your mortgage balance each month, you will shave off between 6-7 years. Say you have a mortgage for $230,000 at a rate of 4.5% for 30 years. Your payment will be $1165.38 (principal 302.88 and interest $862.50). To save 7 years, you will have to pay exactly $302.88 each month additional to the $1165.38 consistently for the next 23 years so your total payment will be $1468.26. You see why you need to be aggressive? The question is how many people can do this consistently?
Why This Is Difficult..
There are different categories of mortgages and even payments. There are people whose payments comprise of only principal and interest. Then there are those who pay principal, interest and escrow (Homeowner’s insurance + Taxes). The majorities who have escrow with the bank do because they were unable to put down 20% of the purchase price. Having an escrow most likely means they’re paying PMI. Also, even though you have a fixed rate loan, as long as you are paying escrow, your mortgage payment will feel like a yo-yo diet. One year, your payments go up and the next it could go down… or up some more (if you live in New York).
That you made extra payments for the last 10 months doesn’t absolve you from making your actual payment the 11th month should situations arise that makes you unable to pay in that 11th month. Paying extra only saves you back end or future interest.
In the life of a 30 year mortgage, a lot happens; people move and sell, refinance to get money for their kid’s college tuition, home repairs or renovations, paying off their own student loans, start businesses. The list is endless. It is rare for people to stay in and own the same house for exactly 30 year and keep the initial contract the same.
I don’t agree with paying that extra. It is best to just let your mortgage term ride. A dollar today is worth more than tomorrow. If you have that extra, put it towards your child’s education, home repairs, start a business. You know all the reasons people refinance for in the first place and keep having a huge mortgage payment over their head in their old age. You can pay the additional principal if you absolutely have the money. Meaning you have an investment somewhere that yields enough divided for you to pay that extra each month.
Author Bio: Ogechi Linda Igbokwe holds a BSc in Professional Communications and a Masters in Accounting. She has worked in banking for 7 years and created the OneSavvyDollar Curriculum. You can catch her speaking across Long Island and blogging at onesavvydollar.