Ever wonder the impact an extra $10, $50, $100, or $500 could have, when paid to the principal on a loan?
You can see by using an amortization calculator or spreadsheet (link goes to the excel sheet I used above. It’s sweet).
We are extremely early in our 30-year mortgage, having completed only three payments. Loans such as mortgages or car loans are structured so that you pay only a little bit of principal and a lot of interest in your earliest payments, and it gradually adjusts so that by the end of the term you are paying a lot toward principal and not as much to interest. As you can see by my screenshot, our first payment sent $495 to interest and only $173 to principal.
The more we can put toward the principal early in the amortization period, the more money we’ll save off the life of the loan.
We can take a concept from 20sMoney and determine our mortgage balance’s tipping point — that is, the point where we are paying more toward principal each month than interest (without extra payments). For us, with no more extra payments that point will come at month 176, or when we have paid down about 33% of our starting balance.
We could be more substantial with our extra payments until we reach that tipping point, and then shift our extra payments to retirement investments, since more principal would be going to interest at that time.
Our starting mortgage balance was $132,000 at 4.5% over a 30-year term.
Say I paid my mortgage balance every month, and then at the end of the first year, I applied one extra $100 payment toward the principal. The calculator shows that $100 at month 12 would save $265 in interest. Now, say I didn’t make any extra payments until year 4. I put $100 toward principal on month 48, saving only $219 in interest.
Say I don’t make extra payments until year 10. Put in $100 extra, save $143 in interest.
We paid our regular balance for our first payment. For the second two, I rounded up the total amount of the check to an even $850 (this amount is including taxes and insurance).
So far, those two tiny extra payments of $3.51 each have saved $17.84 in interest.
Let’s look at what an extra $3.51/month will do if I paid that tiny extra amount for the life of the loan. I’d save $1,375.59 and pay off the balance three months ahead of schedule. That $3.51/month doesn’t seem so inconsequential now, does it?
An extra $10/month toward principal saves me $3,789 and pays it off 10 months ahead of time.
An extra $20/month would save $7,283 and pay it off 20 months faster.
An extra $50/month saves $16,390 and we’d pay it off almost 4 years early.
An extra $100/month saves $28,194 and pays it off 82 months early.
We haven’t decided how much extra we want to start regularly overpaying.
We DO want to make sure we’re funding our retirement accounts really well from here on out (we’re back at 15% gross going to retirement, plus company match), because just like the power of compounding interest works to reduce a loan balance, it also works to increase our investments. We aren’t maxing out both of our IRAs or Shane’s 401(k), so you could make the argument that we’d better get to that point first, and then take care of the mortgage.
Some people argue that when your mortgage interest rate is low, you’d be better to invest that money in our retirement accounts instead of prepaying the mortgage.
Yes, it’s possible that if we put an extra $100 in our IRA per month instead of toward our mortgage, our portfolio could increase at a higher rate than the interest savings. Or, it couldn’t. Hard to predict. My mortgage balance is a predictable amount because it is a fixed rate. And inflation? Yeah I can’t predict what will happen there.
Here’s the thing: I’m not such an all-star with our budget that I can guarantee we are awesome with every dollar, every month. FAR from it. I can’t say that I wouldn’t fritter away $20 or $50 or even more in a given month, if given the opportunity. I guarantee we fritter away more than $3.51/month.
While I am trying to automate our budget, we are people, not robot spenders.
We want to fund our investments as best as we can right now, but I still think there’s room for paying extra on our mortgage. We can have it both ways.
The amount can be small enough that we won’t notice it’s gone, but big enough to have an impact.
How about you? Are you paying extra on the mortgage? If so, are you putting a fixed extra amount, or throwing as much as you can at it? What are your thoughts on this?