An occasional lump sum principal payment or a more modest amount added to each month's regular payment can save you five- or six-figure money over the life of your mortgage. It does this by accelerating your loan so it will be paid off years earlier than the contractual pay-off date. You can actually skip the calculations and simply add whatever you can afford to each month's mortgage payment, but a goal-oriented plan increases the likelihood that you will stay focused on early repayment.
Pull out your mortgage statement and determine your exact interest rate. This is the interest rate you signed on for when you closed on your loan and is probably labeled "annual percentage rate" or "APR."
Go to an online mortgage calculator such as the one in "Resources" and put in the original principal you borrowed, the term and interest rate, and the original date the loan started. Then, press "calculate." For example, let's use a 30-year mortgage loan of $325,000 that started two years ago and has an interest rate of 4 percent. The calculator shows the payment is $1,561.15. This figure should match the amount shown on your mortgage statement, less whatever additional amounts are charged each month for tax and insurance escrow.
Shorten the term of the loan by however many years you would like to reduce it and recalculate. In our example, let's take six years off of our two-year-old loan and enter 24 years into the "term" box. The recalculation yields a monthly payment of $1,768.06, not counting charges for tax and insurance escrow, and a new pay-off date six years earlier than the contractual date.
Multiply your original payment by the number of months you would shorten your loan to learn your $1,561.15 times 72 months equals a highly motivating interest savings of $112,403 over the life of the loan.
Subtract the contractual payment from the accelerated payment to determine the amount to add to each month's payment in order to reach your goal. In our example, $1,768.06 minus $1,561.15 equals $206.91 to be added to each month's payment to achieve pay-off six years early on our two-year-old loan. This monthly add-on would have been a smaller number if the homeowner had started when the loan first closed and will be larger if he starts the pay-down project later.
- Be sure to check your loan documents or call your lender to determine the procedure for making extra principal payments. Some lenders may want extra principal payments made with a separate check. Others have a space on the payment coupon that you can fill out to give instructions for disposition of extra money sent with the payment.
- Some mortgages come with a "prepayment penalty" clause that adds a hefty sum to principal repayment that exceeds a certain amount in the early years of the contract. This ensures that the lender gets substantial interest money even if you refinance to get a better loan. For example, your loan might specify that you will be charged a percentage of any principal repayment over $20,000 in the first two years of the loan. Avoid the penalty by keeping principal repayment just a few dollars under the limit until the specific time is expired, then rev up your principal payments after that.
Billie Jo Jannen is a politics and lifestyle columnist in rural San Diego County and a senior copy editor for Demand Media. Her writing and editing career spans 23 years, and she specializes in border and environmental affairs. Jannen's eclectic education includes engineering and horticulture, and she represents the Rural Economic Action League in regional economic development planning.