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Big Savings for House
Owner.
On
a typical 30-year
mortgage,
you can save as much as one
third of the total payments and about ten years of paying by
making extra payments on the principal with mortgage reduction. As a result, you save
hundreds of thousands of dollars in interest payments. Usually,
the house payment is the single biggest expense in a family's
budget! You could, theoretically, achieve nearly the same objective by
not making the extra payment on the
mortgage
and instead investing
the money in an account paying interest at the same rate that you
are paying on the
mortgage.
Theoretically. But this doesn't
really work.
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First,
you would have to find a conservative investment that paid at least as
much as you are paying in
mortgage
interest, plus enough extra to cover the tax deduction you are getting
on the
mortgage
interest. Second, what happens in practice, if you don't make the
extra payment and the extra effort to pay off your
mortgage,
is that
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you will
end up spending the money you should have been using to pay off the
mortgage
early. |
The tables on the bottom of the page shows you how it works. Say you
have a
mortgage
of $100,000, borrowed at 9.5%, and payable in 30
years (360 months), in increments of $840.85 per month. Table One
shows that each steady monthly payment will finish off the
mortgage
in roughly 30 years. By contrast, Table Two shows that making extra principal
payments of only $150 will finish off the
mortgage
in about 17
years, because you aren't paying interest on the principal that is
prepaid. Payments on principal are worth far more than just making
an extra payment, which the bank normally applies against current
interest. Each principal payment is a direct
reduction
of the loan
balance, and therefore is reducing the total loan on which the rest
of the interest is calculated.
For example, if you have a
mortgage
with a 10% interest rate,
if you make only ONE extra payment of $500 against the principal,
the following year you would pay $50 less interest on your total
loan because you reduced the loan by $500. Now multiply that
$50 savings on interest (from just one payment against principal)
times 30 years, and you will have reduced your total
mortgage
by
$1,500. Your one time $500 investment has a 300% return! Now
imagine prepaying $500 against principal every year for the full
mortgage
term. You will still enjoy the
mortgage
interest tax deduction
benefits under the current tax laws because although you are
reducing the total
mortgage
cost, you are still paying a hefty
amount of interest. The difference in your tax deduction because
of prepayment will be only a few dollars a year. And there is no
value in paying $100 in unnecessary interest to typically save $40
on taxes.
What
about prepayment penalties?
Very few mortgages today have prepayment penalties.
If you
have an older
mortgage
with a prepayment penalty, read the clause
carefully. Most of them only have a penalty for a complete payoff
in a short period of time -- such as selling the house a year later
and paying the
mortgage
in full, or making a very large payment
(such as 80% of the total) in the first three years. They don't
normally apply to small prepayments.
TABLE ONE: Making One
Mortgage
Payment Each Month
Principal = $100,000 Interest = 9.5% Term = 360 months
Monthly payment = $840.85 (interest + principal)
Scheduled Principal Extra
Loan
Month Balance Payment Principal
Interest Balance
Payment Payment
1
$100,000.00 $49.19 0.00 $791.67 $99,950.81
2 $99,950.81 $49.58 0.00 $791.28 $99,901.24
3 $99,901.24 $49.97 0.00 $790.88 $99,851.27
4 $99,851.27 $50.37 0.00 $790.49 $99,800.90
5 $99,800.90 $50.76 0.00 $790.09 $99,750.14
6 $99,750.14 $51.17 0.00 $789.69 $99,698.97
7 $99,698.97 $51.57 0.00 $789.28 $99,647.40
8 $99,647.40 $51.98 0.00 $788.88 $99,595.42
9 $99,595.42 $52.39 0.00 $788.46 $99,543.03
10 $99,543.03 $52.81 0.00 $788.05 $99,490.23
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204 $75,415.91 $243.81 0.00 $597.04 $75,172.10
205 $75,172.10 $245.74 0.00 $595.11 $74,926.36
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210 $73,923.78 $255.62 0.00 $585.23 $74,926.36
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360 $834.25 $834.25 0.00 $ 6.60 $73,668.16
Total
Interest = $202,707.51
TABLE TWO: Making Extra
Mortgage
Payments Each Month
Principal = $100,000 Interest = 9.5% Term = 204 months
Monthly payment = $840.85 (interest + principal)
Extra principal payment = $150.00
Scheduled Principal Extra
Loan
Month Balance Payment Principal Interest Balance
Payment Payment
1
$100,000.00 $49.19 $150.00 $791.67 $99,800.81
2 $99,800.81 $50.76 $150.00 $790.09 $99,600.05
3 $99,600.05 $52.35 $150.00 $788.50 $99,397.69
4 $99,397.69 $53.96 $150.00 $786.90 $99,193.74
5 $99,193.74 $55.57 $150.00 $785.28 $98,988.17
6 $98,988.17 $57.20 $150.00 $783.66 $98,780.97
7 $98,780.97 $58.84 $150.00 $782.02 $98,572.13
8 $98,572.13 $60.49 $150.00 $780.36 $98,361.64
9 $98,361.64 $62.16 $150.00 $778.70 $98,149.48
10 $98,149.48 $63.84 $150.00 $777.02 $97,935.65
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180 $21,949.06 $667.09 $150.00 $173.76 $21,131.97
200 $4,317.81 $806.67 $150.00 $34.18 $3,361.13
201 $3,361.13 $814.25 $150.00 $26.61 $2,396.89
202 $2,396.89 $821.88 $150.00 $18.98 $1,425.01
203 $1,425.01 $829.57 $150.00 $11.28 $445.44
204 $ 445.44 $837.33 $0.00 $3.53 $0.00
Total
Interest = $101,592.37
Source: by Adam Starchild (Copy Right Material)
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