Reader Question: Can I Cut 5 Years Off My Mortgage?

by Kevin on May 6, 2009

Reader Kim recently commented on my article explaining why you want to close your loan at the end of the month.

I recently applied to refinance my home with our local bank. When talking with my father he had mentioned that by paying a principal payment at the beginning of the loan, that would take 5 years off the loan. Is that true? When would that have to be paid? At closing or separate after the closing?

Your help would be greatly appreciated. Thank you!

I can’t answer her question specifically because all of the important details: mortgage amount, mortgage length, and interest rate. But I can try to address this question in general terms.

How Much Interest Do You Pay on a 30-Year Mortgage?

Yes, you absolutely can reduce the length of your mortgage by paying extra principal. Yes, this will save you a ton of interest.

Here’s an example:

  • Mortgage length: 30 years
  • Mortgage amount: $150,000
  • Mortgage interest rate: 5%

With the above information I can use Karl’s Mortgage Calculator (my favorite web mortgage payment calculator) to determine what the payment would be.

Your monthly payment for a 30-year term would be $805.23. This is for principal and interest only, not taxes and insurance. But in regards to paying down principal the taxes and insurance don’t matter for the comparison.

If you started this mortgage today you would make your last payment in April 2039. You would have paid back the $150,000 in principal plus $139,865.27 in interest. (Yes, you buy the house twice.)

Save Money on Your Mortgage by Paying Extra Principal

We’ve established that you’re going to spend a lot of money buying this house with a standard 30-year mortgage. Have no fear — you can save a ton of money by simply paying additional principal each month (or paying a large amount of principal up front).

If you simply added $100 to every payment — bringing your total payment to $905.23 — you would shave 6 years and 5 months off of the mortgage (finish in November 2032). Your interest paid would drop from $139,865.27 to $105,279.03 — a savings of $34,606.24.

A Little Pre-Payment Goes a Long Way

Here’s the beauty of paying extra principal. A small amount of pre-payment goes a long way.

In the above example you add $100 to every payment and you finish in 23 years and 7 months. Conver that to months and you’ve made 283 months worth of extra payments.

$100 per month extra x 283 months of payments = $28,300 in pre-payment. But you only saved $34,606 in interest. That doesn’t sound all that great.

But wait, don’t forget that you are also saving yourself the whole payment for six and a half years (because you paid the mortgage off early). That’s a ton of extra money.

Yes, You Can Cut Time Off Your Mortgage

So in the end to answer Kim’s question, yes you can cut five years off your mortgage. A little added principal here and there really goes a long way. (Alternatively you could run the math on making one big payment at the beginning instead of monthly $100 extra payments.)

{ 14 comments }

Philip May 6, 2009 at 6:48 am

If you were able to take that full $28,300 that you paid over the life of the loan and paid all that as extra on the first month then you would have it paid off in 19 years 11 months, so you would save another 4 years 7 months of payments. With a total interest payment of $71,025. Since he didn’t want to do the upfront calculation for you.

Finance Nerd May 6, 2009 at 6:50 am

There is no point to making one big prepayment early. If you can do that, just put more money down! It’s the exact same thing. Actually, by putting more down, you would lower the monthly payment, whereas a large prepayment would not changed what you had to pay each month.

But if you put an extra $5K down, or if you add an extra $5K to the first payment, and then you make the exact same payments the rest of the time, the math is pretty much identical. Actually, it costs a little more to pay it with your first payment, because you will have to pay extra interest that first month as compared to putting that money down instead.

Kip Nickell May 6, 2009 at 7:05 am

I understand the logic of paying extra principle so you end up paying less in the long run. Nevertheless, if a disciplined money manager like himself can just pay the minimum payment and put the extra $100 in anything that gets over 5% interest at a very low risk (rewards checking can be found for 6% and other pretty low risk options exist for about the same), won’t you end up with more money in the end? You will be losing 5%, but gaining 6%. So you would compound the amount in your favour. Also, the interest you pay on a mortgage is tax deductible and that is no small amount.

I could understand paying down principle only if you do not believe there is a low-risk investment which can net you 5%.

Garry - thisimprovedlife May 6, 2009 at 7:53 am

My wife and I aim to make overpayments later on in the year. We are both going to contribute an ammount like £100 each which we hopefully won’t miss too much. We currently have a 30 year mortgage, so the extra £200 per month should really take it down.

Bible Money Matters May 6, 2009 at 8:14 am

Just make sure when making extra payments that you specify that it is to go towards the principal of the loan, and not towards prepaying next months payment of principal AND interest. If you don’t specify they’ll often do whatever is best for them, not you.

SavingDiva May 6, 2009 at 8:33 am

Excellent post! I’m working on making a little extra cash every month (May Goal $30) to overpay my mortgage. I hope to reach $100 by the end of 2009.

Kevin May 6, 2009 at 8:35 am

@Philip: Thanks for running the math 🙂

@Finance Nerd: Yea, you’re right. If you had the money to apply up front, why wouldn’t you? The only instance might be if you wanted to keep the money “in reserve” kind of like an emergency fund, and just slowly over time withdraw from that money to pay it off faster.

@Kip: I used to think like you do. Hey, I get the mortgage interest deduction and I can earn more elsewhere. I don’t believe this any longer. The last 1.5 years has shown that yes, you may be able to earn a better return over time… but you may lose your shirt in the short term. Paying down your mortgage is a guaranteed return. Plus many people overestimate the value of the mortgage interest deduction because it only really saves you money once you get past the standard deduction value.

@Garry: The extra £200 should definitely make it disappear a lot faster! Of course that depends on the size of your mortgage, too…

@Bible Money Matters: Yea… thankfully our online systems lets you choose where you want to put the extra money. I’d be really unhappy if it went to principal and interest. That’s garbage.

@Saving Diva: Keep it up! One step at a time is better than no steps at a time.

Finance Nerd May 6, 2009 at 9:35 am

I certainly recognize the value in paying a little each month, my comment was based on the original question you got which prompted this post. He asked about making a large principal payment immediately and the impact that would have. As I stated, there is no reason to do this, as you can just put that money down instead.

However, there is one reason to do this. If you put the money down, your payment will be lower. If you will be tempted to pay this lower amount, then maybe paying the lump sum after closing is valuable, because your required payment will be based on the original loan, not the loan minus the big payment. So, if you lack discipline, this trick might be useful to help ensure you actually do pay the full amount, since it won’t actually lower your required payment.

Jace May 6, 2009 at 10:35 am

@Kip – like Kevin said, with the economy tanking you can’t find 6% rewards checking anymore and even if you could you’re earning 1% over your interest but how much extra do you save by shortening your mortgage by 4, 6 or 10 years… I bet it’s MUCH more than either the 1% and the tax deduction combined. Not to mention you’re earning 6% on what’s in your checking account which won’t balance out to the amount you’re paying the 5% on the mortgage until both the checking account and mortgage balances are the same, 6% on $400 is not earning you more than what 5% on $150,000 is costing you.

Put a big down payment if you can, otherwise pay more on your principal, anything else is just smoke and mirror budgeting.

Larry May 6, 2009 at 10:37 am

Use this site:
http://www.bankrate.com/calculators/mortgages/mortgage-calculator.aspx
plug in extra payments and recalculate.

Des May 6, 2009 at 1:00 pm

@Kip

Don’t forget taxes on the 6% interest you’re making. Depending on where and how you’re earning that 6% that could bring the net earnings down BELOW the 5% you’re paying in the mortgage. It also pays to consider how much you owe on your house and what other deductions you have. We just bought our house a few months ago, but our interest amount won’t exceed the standard deduction this year, so there are no tax benefits for us unless we can get our other deductions up, and even then the amount we save will be trivial.

So, barring some fancy tax-free-investment footwork, I would say that if you’re paying 5% and making 6% you’re still (mathematically) better off pre-paying the mortgage.

Finance Nerd May 6, 2009 at 2:43 pm

Des, you are paying taxes on the 6% return, but you are also saving taxes on the 5% mortgage interest, so the taxes don’t matter. Or, to be more accurate, they matter, but they are applied to both the income you make and the interest you pay, so they basically wash.

At a 20% tax rate, you are earning 4.8%, and paying 4%, so this decreases the savings a little, from 1% to .8% but it doesn’t eliminate it.

This of course assumes you itemize and would be able to itemize even without the mortgage interest.

bj anderson October 29, 2009 at 8:37 pm

i am refi ing my mortgage and will close very soon.. my lender sayd the payoff on the mortgage is 140,000.00 which i agree with…. he tells me there will be an additional 2600.00 added to that in interest…. can he do this?

Kevin October 30, 2009 at 9:43 am

Without knowing your individual situation in regards to the mortgage I can’t really tell you if that sounds or not.

I wouldn’t sign anything I didn’t understand. If your lender can’t explain in plain english to you what is going on, I would be careful.

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