Paying Off Your Mortgage Early
By Mark Barnes,
il-odm.org Staff Writer
Even though there are 10, 15 and 20-year terms, mortgages are designed to be paid off in 30 years. There are three reasons for the three-decade home loan. When banks began originating home loans long, long ago, most people wouldn't consider applying for a mortgage until they had amassed a considerable savings. So, most home buyers were already in their thirties or older, before ever applying for their first mortgage. With a life expectancy of about 65, back in those days, bankers figured after 30 years, the borrower would pass away, so this seemed like a reasonable amount of time for a loan.
The other two reasons are a 30-year amortization schedule allows for a smaller, more manageable monthly payment, and, the most important reason for the lenders, banks collect tens and sometimes hundreds of thousands of dollars in extra interest payments, over a 30-year period off time.
With mortgages being front-loaded toward interest, banks make a fortune even in the first few years of almost any home loan. For their part, borrowers seem stuck in a never-ending cycle of paying mountains of interest, in exchange for living the American Dream. There is a way around this, however, even though few home buyers choose this path.
The best way to maintain a small monthly mortgage payment while eliminating mammoth interest payments is to pay off the principal balance of your mortgage early.
Now, most lenders or mortgage brokers simply recommend a shorter term, which does accomplish this goal, to a certain degree. The problem with shorter terms, though, is twofold. First, you are locked into a much higher monthly mortgage payment. In other words, you don't have the option of paying less, if your payment is $2,000 on a 15-year mortgage, rather than $1,600 on a 30-year term.
Second, you will actually pay less interest, and meet the same goal, if you simply add extra payments to the principal balance periodically.
The best way to see how this works is to run some of your own figures on the “What If I Pay More Each Month” calculator, here at il-odm.org. Consider this example, though.
Take a $200,000 mortgage, with a 15-year term and 6% interest rate. Compare this to the same loan amount, with a 30-year term and 6.25% rate (smaller terms usually carry a bit better rate). With the 15-year term, you have a monthly mortgage payment of $1,687.71. The 30-year mortgage payment is a much cheaper $1,231.43.
Let's suppose you add the difference in these two payments of $456.28 each month to your 30-year payment. You'll see, if you put these figures into the “What If I Pay More Each Month” calculator, you'll still pay off the loan in just over 15 years, and you’ll save over $131,000 in interest payments.
The beauty of taking the 30-year program is that you are not locked in to the much larger 15-year payment. If a month comes along when money is tight, you simply pay your standard 30-year payment.
Adding to your monthly principal mortgage takes discipline, but in the long run, it’s a great way to save money on your home loan. Also, take a look at our bi-weekly mortgage page.
- Mortgage Professor
- From the Fool