Over the life of a mortgage, a borrower is paying back not only the principal amount of the mortgage but also the interest. Over the term of the mortgage, typically thirty years, the interest can add up to the tens of thousands of dollars. There are a couple ways to avoid paying a large portion of that interest and to pay off the mortgage years earlier, but regardless of the specific method, the basis of paying off a mortgage early is to make extra payments on principal, preferably extra and more frequent payments. Even if the extra amount is small, over time, it has a very significant impact on both the total interest a borrower will pay, but also on how long it takes to pay off the mortgage.
Extra Payment on Principal
All mortgages follow an amortization schedule, which is simply a spreadsheet that shows how each payment for the entire life of the loan is allocated, showing how much goes to interest and how much of the remaining amount is applied to the principal loan amount. When a payment is applied on a mortgage, the money first goes to pay off the daily interest that has accrued since the last payment, or, if it is the first payment applied at the start of the loan, it goes first to pay off the interest accrued since the start date of the loan. The rest gets applied to the principal. The daily and monthly interest that accrues is based off a percentage of the current loan amount. Therefore, making larger reductions to the principal amount will pay off the mortgage quicker than stated in the amortization schedule and avoid paying back as much interest. For example, if the minimum monthly payment is $500 and if the amortization schedule states that $400 goes to interest and $100 goes to principal, and if the borrower makes a $600 payment, then $400 still goes to interest, but now $200 goes to principal instead of $100. That extra $100 reduction in principal will cause the amount of interest that accrues until the next payment to be less than what is stated in the amortization schedule. If this is done every month, even if the extra amount paid is less than $100, the cumulative effect over time will greatly reduce the amount of interest that is paid and will cause the loan balance to fall faster, thereby paying it off sooner. A variation of this method is to simply make one extra payment per year. This method also helps but is not as effective as it usually does not make as large of an overall reduction to principal and it also does not make frequent reductions in accrued interest.
Pay Every Two Weeks:
The most effective method to pay off a mortgage early is to make half of the standard payment exactly every two weeks. This means making 26 half payments per year, so there will be two months out of the year in which three half payments are applied. The reason this is so effective is that it makes more and more frequent reductions in principal. This avoids a large amount of interest being accrued because every 14 days, the interest is paid off and the principal is reduced. Also, making twenty-six half payments per year means that there will be one extra payment standard payment applied. In other words, the borrower makes a cumulative total of thirteen standard payments by the end of the year instead of twelve. The cumulative effect of this will cause a standard fixed rate thirty-year mortgage to be paid off in a little over nineteen years and avoid almost nineteen years of interest charges. When following this method, it is very important to do it from the start of the loan. Fourteen days after the official effective date of the loan, a half payment should be applied, and this should continue to be applied every fourteen days. A variation to this method that will pay off the mortgage even quicker is to pay extra on principal every fourteen days. For example, if the standard monthly mortgage payment is $1,000, then the borrower would pay $500 every fourteen days. However, if the borrower chooses to and can afford to, paying $550 every fourteen days will have an additional impact. Paying the minimum $500 every two weeks still makes reductions in the principal but adding even an extra fifty dollars per payment has a very significant effect over time because the entire extra amount over the minimum payment required goes to reduce principal. This extra reduction in principal on top of the benefits of the half payment method has a huge effect on the interest and the life of the loan because there are two factors reducing the principal which in turn reduces the interest paid. Even if the extra paid over the minimum is small, it still has a significant impact on the loan.
When using the half payment method, it is very important to keep in mind that it has to be done consistently. A half payment has to be applied every fourteen days for this method to work the most effectively. Some mortgage servicing companies will have programs available to borrowers that are designed specifically for this payment method and will allow the borrower to set up a bank account that the half payment will be drafted out of automatically every fourteen days. Also, many banks offer bill pay services to their customers that will allow the borrower to set up payments to be sent electronically from their bank to the mortgage servicing company every fourteen days. It is important to be able to set it up to be paid automatically because mailing a physical check in to the mortgage servicing company and having it applied consistently every fourteen days is very difficult to maintain due to variations in mail times and simply due to the difficulty of remembering to mail off the check every two weeks.