Mortgage Prepayment Advice
- Your mortgage payment consists of principal and interest (P&I) and payment into an escrow account. The escrow is to pay property taxes and insurance. The P&I is the amount toward repaying the mortgage loan. In the early years of a mortgage, the majority of the P&I is interest being paid to the mortgage lender. For, example a 30-year mortgage of $150,000 at 6.5 percent will have a P&I amount of about $950, and only $140 goes to principal during the first year. As the years go by, the amount of principal from each payment will increase and the interest portion will decrease. If you pay the full 30-year term of this $150,000 mortgage, the P&I payments will total $340,000, with almost $200,000 paid in interest.
- Prepayment of mortgage principal eliminates the payment of interest on that amount of money for the remainder of the mortgage. A one-time $100 payment in the first year of a $150,000 mortgage saves $584 in interest over 30 years. A prepayment plan that doubles the first-year principal payment by adding $140 to each payment would save over $64,000 in interest and pay the mortgage off nine years early. It is important to understand that paying extra on a mortgage payment does not reduce the amount due for the next month. The amount of the payment due will stay the same until the mortgage is paid off. Additional principal payments go toward reducing the total number of payments over the life of the mortgage.
- Compare the results of paying extra toward a mortgage with other uses for the money. If you have other debts, such as credit cards or auto loans, at a higher interest rate than the mortgage, extra principal payments to these loans will reduce your interest paid faster. Savings or investment plans that earn a higher rate of return than the interest rate of the mortgage will increase your net worth faster if you invest the money. However, paying down credit cards or adding to savings will not accomplish the goal of being debt free if the cards are used again or the money in savings is withdrawn and spent. Mortgage prepayment is a permanent solution to debt reduction that cannot be undone without selling the house or refinancing.
- Becoming debt free and owning a mortgage-free home is a long-term goal that requires a workable plan and discipline. The first step to living debt free should be to pay off high-interest credit cards and stop using them. Next, calculate and follow a plan for mortgage reduction. Initially, you can make small additional payments to principal and increase them as your income increases. Each month, review your debt balances and the current projection of when you will be debt free. Prepaying a mortgage is a long-term plan to become debt free. The benefit is that when you are debt free, you have freedom in your live to travel, change careers or retire early.
