If you have a bit of extra money on hand, and want to use it to its best effect, making extra payments on your mortgage loan will shorten the length of your mortgage and decrease the amount of interest you pay over the extent of the loan. Depending on the terms of your loan, a one-time payment of even $1000 or so dollars early in the life of the loan can save you five-figure money in interest over the life of the loan and accelerate pay-off by months, or even years. A disciplined homeowner that makes a set monthly principal payment can save even more and build up serious equity much earlier in the life of the loan.
Ask your lender how you should note the disposition of extra payments. Some lenders may want extra principal payments to be made with a separate check. Others may have a place on the payment coupon to note the disposition of extra money sent with the regular payment. You can get this information from your mortgage agreement or by calling the lender.
Go to an online mortgage calculator (see Resources) and plug in your mortgage amount, interest rate, start date and term. The resulting payment should match the one in your mortgage agreement. For example, a $200,000 mortgage with a 30-year fixed rate of 4 percent, starting in Oct. 31, 2010, would yield a payment of $954.83, and a pay-off date of Oct. 31, 2040.
Enter the monthly amount you think you can afford over and above the regular payment into the "Extra Payments" section below the initial calculation and click on the "Recalculate Amortization" button. If we use the example of the $200,000 mortgage with a monthly payment of $954.83 and you enter an additional $100 a month, your total monthly payment will be $1,054.83.
Check the new pay-off date. In the case of the $200,000 loan, that $100 a month extra has given a new pay-off date of Nov. 30, 2035 -- an acceleration of 59 months.
Multiply your monthly payment by the number of payments you eliminated to learn how much money you will save by paying down the principal faster. For example, the payment amount of $954.83 times 59 yields an impressive savings of $56,335 in interest.
Experiment with larger or smaller monthly amounts to get a feel for what you can accomplish within your means. The calculator also has a box for calculating one-time payments. For instance, an immediate one-time payment of $5,000 on the same $200,000 loan would change the pay-off date to June 30, 2039 -- an acceleration of 16 months and a savings of $15,227 in interest.
Add the amount you have decided is appropriate to each month's payment, either as a separate check or included in the check for your regular payment. Be sure to note on your payment coupon that the extra money is to go against your principal balance. The procedure will be exactly the same for a large one-time payment.
- Don't be taken in by companies that offer to help you accelerate your loan in exchange for a hefty fee. You will be paying them to do what you can easily do yourself without locking yourself in to another monthly contract.
- 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. For example, your loan might specify that you will be penalized 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.