Adding extra money to your monthly house payment will definitely shorten how long it takes to pay off the loan. Because of how mortgage interest is calculated, additional principal payments produce an inverse compound interest effect, where a little extra payment can produce a large financial benefit. With enough extra added to your monthly mortgage payment you can shave years off a 30-year loan term.
Calculating Mortgage Interest
The monthly interest you pay is based on the interest rate of the loan and the outstanding balance. Any leftover payment after the interest goes to pay down the principal. As payments are made, the amount of interest charged each month declines and the principal reduction amount increases. Consider a 30-year, $150,000 loan at 6 percent with a payment of $900. Monthly interest of 1/2 percent means $750 of the first payment goes to interest and $150 to principal. For the next month, interest is calculated on a balance of $149,850 for a result of $749.25, and the balance is reduced by $150.75.
Extra Payment Effects
Since the monthly loan interest is based on the current loan balance, paying extra on your house payment has the effect of lowering the future interest you pay as well as paying down the principal at a faster rate. Each extra payment amount reduces every future interest charge and increases each principal reduction amount. Due to the long-term interest savings resulting from extra payments, the sooner you start adding extra payments to your mortgage payments, the quicker you will be able to pay off the loan early.
The $100 Example
Consider the effect of adding just $100 to the first payment of the hypothetical 6 percent, $150,000 mortgage. The result of the single extra $100 would be a reduction of $502 in total interest paid. If you sent the $100 with the first nine payments -- to equal one extra payment -- you save more than $4,300 in interest and knock five full payments off the term of the loan. An online or spreadsheet mortgage calculator will show how much you can save based on your loan details and how much extra you want to send in.
Consider Your Options
Adding money to your mortgage payments will pay off your loan quicker, but be aware that you do not see the benefits of those extra payments for a long time -- until the last dollar of principal has been paid off. Paying more now does not give you the option of making smaller payments in the future. The extra cash you send goes to reduce the loan balance and you cannot take it back. Be careful not to overstretch your budget to send in extra-large home loan payments.
Tim Plaehn has been writing financial, investment and trading articles and blogs since 2007. His work has appeared online at Seeking Alpha, Marketwatch.com and various other websites. Plaehn has a bachelor's degree in mathematics from the U.S. Air Force Academy.