What Difference Does it Make When You Put Down Extra on Your Mortgage Every Month?

Posted by Content Team on Dec 19, 2019 7:11 PM

When we live paycheck-to-paycheck like so many Americans do, we can lose a long-term perspective on our financial decisions. But since a mortgage is definitely a long-term commitment, those who have one ought to consider how their monthly contributions will pay off years down the road.

Obviously paying too little is something that is frowned upon by lenders, but what about paying over what is required each month? Because of the way interest works, paying extra can make a huge difference in the total amount you will end up paying for your house – potentially knocking off thousands of dollars over the life of your loan without going through the hassle of refinancing!

Principal and Interest

Some background first.

When you make a payment on any loan (not just a mortgage), a portion of your check goes to principal, and a portion goes to interest. The principal is the amount that you have actually borrowed from your lender. The balance of principal that remains on your loan is the amount of money that you owe your lender.

Interest is added to this based on the interest rate you’ve locked in for your loan and the principal remaining to be paid off.

As you begin to make payments on your mortgage, most of the money you pay each month goes toward interest, since your principal is still so high. Only a small amount goes toward paying down the principal, or balance, of your loan. If you look at the details of where your money is going as shown on each statement you receive, you may find yourself being pretty discouraged. It takes a while to gain traction, but as you keep paying and as the principal decreases, more and more of what you spend each month on your mortgage goes toward the principal while less and less goes toward interest.

What this means is that the higher your principal is, the more you pay in interest over the life of your loan. Strategically, then, if you can get your principal lowered as quickly as possible especially in the early years of your loan, you will avoid paying a significant amount in interest.

Which means that by spending a bit more every month, when you are done with your mortgage (even if you don’t stay in your house until the very end) you will have saved even more.

Paying Extra On Your Mortgage 

The reason why there is such a benefit to paying extra on your mortgage is that the additional amount you pay will be deducted directly from the principal of your loan, provided you follow any relevant procedures your bank has. For most, though, this is as easy as adding a bit extra to each payment you make.

So if your regular mortgage payment is $1800 per month, and you choose to pay $2000 per month, then you will be reducing the principal by an extra $200 every month. That may not sound like a lot of money (especially compared to the balance of your loan), however, when you take into consideration the decrease in interest payments that this reduction in the loan premium will save you, you are really saving quite a bit.

Compared to the amount of interest income you might be able to generate in a typical savings account, paying additional amounts off your mortgage is likely to be a far superior investment in the long run. 

How Much Money Could I Save by Making Extra Payments Every Month? 

Staying Until the End

Let’s take a 30-year mortgage of $200,000 with a fixed interest rate of 3.5%. If you overpaid by just $50 per month every month – which means your principal is being reduced by an extra $50 each month – you would save $12,356 over the lifetime of the mortgage, and your mortgage would be repaid two years and seven months early. You might be thinking “I do not have $50 extra every month,” but how much do you pay at your local coffee shop during the same time period? Let’s assume the average price is $3 per coffee, and you have one a day Monday through Friday. That equates to $15 per week, which is $60 per month. Can you figure out another way to get your daily dose of caffeine and save $12,356 over 30 years?

Let’s say you become even more focused and overpay by $100 every month. Thanks to the wonders of compound interest, you would save $22,367 and pay off your mortgage four years and nine months early. 

As one final example, let’s assume you really tighten your belt and manage to throw an extra $250 per month at the mortgage. You would save $43,638 in interest, and have your mortgage paid off nine years and seven months early. Let that sink in for a second, nine years, and seven months. Imagine what a difference that could make to you and your family’s life. Imagine not having a mortgage payment at all. Some sacrifice now could change the financial trajectory of your life!

Selling Before You’re Done

But what if you’re not planning to stay in your house for 30 years? It still makes a difference, as you’ll be able to make more money on the sale of your house.

The sale price won’t change – but the amount in your pocket will. Once the bank in charge of your current mortgage is paid off of the remaining principal of your loan, then you get to keep the extra or put it down on a new house. Of course, the less principal you have remaining on your loan, the more money you will get.

Early Payments and Taxes

One possible objection to making payments early is that you are only able to deduct the amount of interest you have paid on your mortgage on your taxes. So if you are paying less interest, your deduction will be less.

This is true, however, thanks to recent tax reforms the standard deduction is so high that most people will end up taking that rather than itemizing their deductions. This means that mortgage interest payments won’t make a difference for most people. It is also likely that in the long run, you will save more by paying off your mortgage early than you would gain from tax rebates. Of course, this is a subject that is better left to tax professionals. Talk to a tax advisor in your area to determine what is best for your situation.

Different Ways to Pay Down Your Mortgage

We understand that not everyone will be able to afford to overpay on their mortgage every month. But don’t despair, because any extra payment you can make will make a difference.

If your budget is just too tight and a monthly overpayment is not an option, then you could commit to making one extra payment every year. If you regularly get a Christmas bonus, for instance, or a sizeable tax return, consider applying it to your mortgage. 

Alternatively, there are certain times in your life where you may come into an unexpected sum of money. You may be left some money as part of an inheritance, for instance. Most people who leave you money do so because they care for you, and so they would probably be delighted if you used that money to reduce the amount of your mortgage and save thousands of dollars in interest – enabling you to do more of the things you love and perhaps to leave an inheritance after you, too.

Make a Plan

Use this extra payment calculator to play around with your payments, and set yourself the challenge of being mortgage-free.

If you have any questions about paying off your mortgage or want to discuss your options, then make an appointment to speak to me today. 

What has your experience been with early mortgage payoff? Comment below to share.

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