Wednesday, November 22, 2006

Paying Off a Home Mortgage Earlier

An easy way to pay off one’s mortgage faster is to increase the monthly payment and ask the lender to apply that amount to the principal. Check first with the lender that there are no prepayment penalties.

The impact of the additional payment varies depending on the interest rate and mortgage term. The higher the interest rate and the longer the term, the faster the mortgage is paid off for a certain percentage increase in your payment.

Here are a couple of examples for a 30 year mortgage. Each example shows the years of reduction and the required percentage increase in your monthly payment.

5% Interest Rate

5 year reduction – 8.9% increase
10 year reduction – 22.9% increase
15 year reduction – 47.3% increase

7% Interest Rate

5 year reduction – 6.2% increase
10 year reduction – 16.5% increase
15 year reduction – 35.1% increase

For those of you proficient in Excel, I used the Excel PMT function to calculate the examples. PMT requests 3 inputs (rate, nper, pv). Rate is the interest rate per year divided by 12. Nper is the term of your mortgage in years times 12. Pv is the amount of the mortgage. By varying the number of years (Nper), you can determine the monthly payment increase needed to pay off your specific mortgage earlier.

A couple of final points:

There are several services that charge you for the administrative work of doing additional payments to a mortgage. One can easily save the money by doing the calculations above (or have your lender do it) and working with your lender directly to apply the additional payments to principal.

When thinking about a 15 year mortgage, consider getting a 30 year mortgage and making higher payments to pay it off in 15 years. Since you can choose to make a smaller (30 year mortgage) payment, this gives you the flexibility to have extra money should you need it. If you are committed to a 15 mortgage, you must make the higher payment.

This is not financial advice. Please consult a professional advisor.

Copyright © 2006 Achievement Catalyst, LLC

1 comment:

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