Burn the Mortgage Early

Save Interest

Save thousands of dollars in interest charges and burn the mortgage early! Invest a few minutes learning how loan amortization works and then put your plan into action. The subject may sound complex or even boring, but read on. You might decide you could retire a few years earlier. First, let's review some terms that apply to loans. PRINCIPAL is the amount of the money borrowed. BALANCE is the amount of principal left after a payment is made. INTEREST is the fee paid to a lender for borrowing money. AMORTIZATION is a term for money needed in each payment to pay of a loan over a period. An AMORTIZATION SCHEDULE is a table showing the interest and principal part of each payment. A PREPAYMENT is a payment made before its' due date.

Your Current Loan Payment

It is important to remember that your mortgage loan payment typically includes an escrow account for taxes and insurance. Thus, when those bills become due, the lender will make those payments. If you pay off the mortgage you will have to save that money to pay those bills yourself. So you wll be saving the principal and interest portion of your mortgage payment but not the taxes and insurance funds. In many cases these escrow payments can be the largest portion of your mortgage payment, so your monthly saving will be less than you thought.

Amortization

In order to keep payments level over the course of a loan, lenders compute the amount of interest for each payment and credit the remainder to the loan principal. Since the loan principal decreases with each payment, the amount of interest on the next payment decreases. And the amount of the principal reduction increases. or example, a $100,000 loan with a 7.5% interest rate will have interest due of $7,500 per year. However, since mortgage loans are repaid monthly, the amount of principal reduces monthly. Calculate the interest on the first payment by taking 7.5% of $100,000 and dividing the result by 12. (Each month is one twelfth of the year.)

The interest on the first payment would be $666.70. By referring to an amortization table, you can find that the principal on the first payment would be $54.63 for a total of $734. The second month's interest is computed on the remaining loan balance of $99,945.37 so the interest will be $666.30 and the principal reduction will be $67.70.

Loan Amortization

Understanding how amortization works will help you understand how you can save a substantial amount of interest by reducing your loan balance faster. Many borrowers are choosing fifteen-year loans when they refinance, just so they can pay the loan off faster and pay about two thirds less interest.

The savings are apparent when the interest rates are equal, but most lenders offer lower interest rates on fifteen-year loans so the savings are even greater. Typically, fifteen year loans carry interest rates that are 1/4 to 1/2 per cent lower than the thirty ear rate. The spreads vary according to money market conditions.

Extra Payments

But, homeowners who already have thirty-year mortgages can also enjoy interest savings by sending in a little extra money with each mortgage payment. Most mortgage payment coupons include a line for "additional principal."

By simply paying fifty extra dollars per month, the borrower can pay off a $100,000 thirty-year mortgage in 23.5 years and save $49,433.67 in interest. Not a bad return for an investment of $14,100 in total extra payments

In understanding amortization, it is also useful to understand the term negative amortization. his simply means that an amount of interest is added to the loan balance with each payment

Negative amortization is typically a feature of adjustable rate mortgages that are adjusted to the 11th District Cost of Funds Index. These loans usually adjust either monthly or on a semi annual basis. Since the loan payment stays level for a year, the difference between the interest charged, and the actual interest is added to the principal of the loan.

For example, a negative amortization loan may have a level payment of $1000 per month at an interest rate of 8.5%. If the interest adjusts up to 9.5%, the payment stays the same but that 1% additional interest would be added back on the loan. On a $100,000 loan that amount could equal $1000 per year. After a few months, you can actually owe more than when you started!

Shorter Term Mortgages

As you can see, there are great benefits to shorter-term mortgages or as an alternative, paying additional principal with each mortgage payment. And with today's meager return on CDs, it is a better investment to pay off mortgage debt then to accept the small amount of interest earned.

Pay Off Your Mortgage or Invest Your Money?

Some would argue that it is better to invest money in the stock market than to pay off the mortgage early. Many people with low rate mortgages do just that and enjoy the income from investments. The spread between the mortgage rate and the rate of return on investments can often provides a significant profit. Off course the rate of return on investments will vary over time while the mortgage rate will remain the same.

Need for Cash

If you pay off your mortgage, you can always raise cash for an emergency with a home equity loan or a reverse annuity mortgage. The interest on such loans will usually have the added benefit of being tax deductible.

"He's happy who, far away from business, like the race of men of old, tills his ancestral fields with his own oxen, unbound by any interest to pay." Horace.