› Budget101 Discussion List Archives › General Budget & Finance › How Mortgage Prepayments Work

- This topic has 1 reply, 1 voice, and was last updated January 3, 2006 at 8:35 pm by .

- AuthorPosts
- January 3, 2006 at 8:35 pm #235167Liss
How Mortgage Prepayments Work

The Dollar Stretcher

by Gary ForemanGary,

I once heard a financial planner say you can reduce the numbers of years it

takes to pay your house off. She said that if you make one extra house

payment a year, you could reduce a 30-year mortgage to 22 years and a

15-year mortgage to a 12 years. Can you please explain how this works?

rm in flwhat rm heard was generally correct. but lower interest rates have changed

it a bit. let’s explore mortgage prepayments and how to make them work.first, recognize that there’s a big advantage to getting your mortgage paid

off. it frees up a sizeable amount each month that can be used for other

things.yes, it’s a big long-term goal. but, unlike some other distant goals, you

don’t need to get to the finish line to benefit from your efforts. even if

you only prepay principal one time, it will make every regular payment

after that more efficient.rm will want to get familiar with something called an ‘amortization table’.

it shows month-by-month how much of each payment goes to paying interest,

how much to reducing principal and what the remaining balance of the

mortgage is.the key factor in paying off any mortgage is how much of the monthly

payment goes to reducing the principal amount owed. for instance, rm would

be in the 18th year of the 6% 30-year mortgage before half of his payment

went to principal repayment.A 30-year mortgage for $150,000 at 6% interest will earn the mortgage

company $173,757 in interest. The monthly payment will be $899.33. But in

the first month only $149.33 of principal will be repaid.What happens if RM does make an extra payment each year? Fortunately a

mortgage calculator does the math for us. I’m partial to one at Bankrate.com

<https://www.bankrate.com/dls/calculators/mortgages.asp>One extra payment per year would reduce the length of the loan to 24 years

and 9 months. It also would reduce the amount of interest paid over the

life of the loan to $138,295.Back to RM’s question. Why doesn’t the annual prepayment reduce the 30-year

mortgage to 22 years? It’s because of the low interest rates.If the rate

were 9.2% then one extra payment a year would reduce the term to 22 years.Same deal for a 15-year mortgage. At a rate of 5.25%, the mortgage would

require a monthly payment of $1,205.82. One extra payment per year would

reduce the term to 13 years and 5 months.OK, so we agree that prepaying your mortgage is a good thing. But for most

families making an extra mortgage payment doesn’t seem like a reasonable

goal. Yet, it isn’t impossible.One way to be successful is to break it

down into 12 monthly parts.By adding $74.95 ($899.33 divided by 12) to each monthly payment RM would

be doing the same thing as making one extra payment per year. The length of

the mortgage drops to 24 years and 7 months.A simple change in lunch or entertainment habits could provide that much

saving. Just think of it as trying to avoid spending $2.50 per day. Or, if

reducing spending isn’t possible, perhaps rm could use his next salary

increase for mortgage prepayment.refinancing your current mortgage could also be a solution. instead of

using the extra money for other things, continue making the same monthly

payment that you made before the refinancing.suppose that rm had a $150,000 8% mortgage and refinanced to 6%. The

difference in payments is $201.32. But if RM continued to pay the $1,100

that they had been paying before the refinancing, he’d have the mortgage

paid off in 19 years and two months.Before you make any prepayments you need to check your mortgage for two

things. First, verify that prepayments are allowed. Second, make sure that

any extra amounts that you send in are applied to reducing principal.In

fact, you’ll probably need to indicate on your check or the payment stub

how much extra is meant for principal reduction.It’s a good idea to make sure that the bank is applying any prepayments

correctly. More than one person has had a prepayment applied as an ‘early

payment’ for the next payment due. That will not do you any good.There are services that charge to check your balance. But it’s really not

that difficult if you have a copy of the amortization table. Based on the

previous month’s principal owed, the table will tell you how much of your

regular payment would go to reducing the principal.With that and the

amount of your prepayment, you’ll be able to calculate the new balance.

Just verify that amount with the mortgage company by phone or the web.

__________________Gary Foreman is a former financial planner who currently edits The Dollar

Stretcherwebsite

- AuthorPosts

- You must be logged in to reply to this topic.

› Budget101 Discussion List Archives › General Budget & Finance › How Mortgage Prepayments Work