• Gary Sandler
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    Published 3 February 2019

    With lots of home sales come lots of new mortgages. And with each of those new mortgages come lots of monthly payments — 360 in the case of a typical 30-year loan. Each of those monthly payments is made up of multiple components; such as principal and interest, reserves for taxes and insurance and in some cases, mortgage insurance.

    A buyer who takes out a new 30-year mortgage of $150,000 at 4.5 percent interest will have a monthly payment that includes a principal and interest component of $760.03. Pay that amount 360 months in a row and the loan is paid in full. Pay a little more than that amount each month and two things happen: the amount of the interest paid is significantly reduced and the amount of time it takes to pay off the loan is dramatically shortened. Here’s how it works.

    Upon making his or her very first principal and interest payment of $760.03, a buyer will see $562.50 of the total go to paying the first-month’s interest. The remaining $197.53 goes toward paying off the principal portion of the loan.

    With each subsequent payment, the principal portion of the payment increases by a few bucks while the amount of interest decreases by an equal amount. By the time the 360th payment of is made, just $2.84 goes toward the interest.

    The key to saving time and money in the long run is to begin attacking the mortgage balance from day one. The whole idea is to reduce the amount of mortgage interest paid by accelerating the reduction of the principal portion of the loan. The amount of interest paid and the time needed to retire the mortgage decline in direct relation to the number of extra dollars paid toward the loan balance each month.

    Adding an extra $50 per month to the monthly payment in our $150,000 scenario saves $17,042.70 in interest and knocks almost three and a half years off the original 30-year term. Increase the additional payment to $100 per month and the amount saved rises to $29,717.25 and reduces the loan term by more than six years. Go wild and pump up the payment by an additional $150 and voila, the buyer pays $39,564.42 less interest and retires the loan eight and a half years ahead of schedule. Some buyers opt to use their income tax refund or yearly employment bonus to make one large extra principal payment each year in place of a monthly contribution. Some do both.

    Paying an extra $100 each month on a loan is like investing $100 each month in some sort of investment vehicle. Since mortgage rates are always higher than savings rates, a borrower would realize a better return by paying down a guaranteed 4.5 percent mortgage than he or she would by depositing the money into a smaller rate-of-return savings account. The downside of such a choice is that the savings account is liquid, meaning that the money is easily accessible, whereas the money paid toward the loan becomes home equity, which is more difficult and costlier to access.

    It’s important that borrowers check the terms of their mortgage to make sure they aren’t charged a prepayment penalty when adding additional dollars to their principal payments. Most conventional, FHA, VA and USDA mortgages are typically penalty-free and allow additional payments at any time.

    Buyers who have made regular payments for several years, especially if their mortgage interest rates are higher than rates are today, will realize a greater rate of return. They can begin making additional payments whenever the urge strikes, especially if they don’t have a better use for the money. The effect will be slightly less dramatic, but the savings of both time and dollars will still significantly accelerate the date of that mortgage-burning party.

    See you at closing!

    Gary Sandler is a full-time Realtor and owner of Gary Sandler Inc., Realtors in Las Cruces. He loves to answer questions an can be reached at 575-642-2292 or Gary@GarySandler.com.

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    • About Author

      Gary Sandler