How Much Of Your Mortgage Payment Goes Towards Loan Principal?
If you have a mortgage that is only a few years old, then likely the majority of the payment goes towards interest. While mortgage interest is tax deductible, it definitely is deflating to see how much money is going towards the bank and not toward paying down your mortgage. It takes several years of paying out massive interest before you actually start putting a dent in your loan balance.
I have been thinking a great deal about paying down my mortgage and what that might look like. The encouraging aspect of paying extra money against your mortgage is that paying extra money now will have an effect on every future payment – namely, by paying an extra $1000 today, every future payment will have more of my money towards the principal versus interest.
I decided to take a look at various mortgages and see at what point in the amortization schedule would I at least half of my payment go towards principal versus interest. This “tipping point” is a great place to get to since more of your money is going towards your own equity / savings versus paying a bank interest! The tipping point is determined by the interest rate on your loan as shown here:
- Interest rate: 4.75% / Tipping point: 34% of loan balance
- Interest rate: 5% / Tipping point: 36% of loan balance
- Interest rate: 5.5% / Tipping point: 39% of loan balance
- Interest rate: 6% / Tipping point: 41% of loan balance
These are approximate values and assumes a 30 year fixed mortgage
So, since my mortgage is a 30 year fixed, 4.75% interest loan, I am shooting for that 34% mark as my tipping point. When I have 34% of the loan paid off, more than half of my payment every month is going towards additional principal on the mortgage. As such, I may aim to viciously attack my mortgage until I get to that point. By attacking the mortgage early on the front end, you make a difference for the remaining time that you service the loan (as opposed to waiting 10 years and then going after your loan). The process is similar to compounding interest, the more you do early, the larger the impact.
The psychological impact of getting past the tipping point is fairly large. Many people tend to talk about owning a home as this wonderful thing and renting as “throwing money away”, but most people pay tons of interest and hardly any money towards the equity of their home. Passing the tipping point will allow you to actually get to a point where you’re not throwing money away. Your monthly housing expense IS actually putting money away. Psychologically, knowing that my payment every month is having a large impact on my financial picture would be huge.
Getting To The Tipping Point
Getting to this tipping point is no easy accomplishment. Like most things in personal finance, the earlier you start and the more you do during the early stages, the better. The problem is that the early stages are often the hardest times to make these strides. During your younger years, your earning power isn’t as high and you might still be paying off debt or recovering from financial mistakes.
Couple this with a massive recession and decreased incomes everywhere you look. How the heck am I supposed to pay down my mortgage these days? Well, you might not be able to or it might just require some pretty tough choices. I’m doing my best to sacrifice in some areas and move towards this goal. I encourage you to do the same.
I'm a big fan of paying down the mortgage. I'm not doing it as aggressively as I could because I still want to have a good amount of cash in case the market falls again or we see another dip in the economy. My payment is approx. $1300 and I pay an extra $400 every month. I still don't see a lot of movement in the principle but I think your point about compounding interest is spot on. As with all good financial strategy, slow and steady makes a whole lot of progress over time.
Thanks for the post, it's good to get a reminder that I'm actually spending that $400 wisely, even if it doesn't always feel like it.
$400 / month is awesome! What kind of cash reserve do you have?
I've currently got a cash reserve of around $18K. That includes my emergency fund and all other liquid assets (ie. Money Market).
There is a good possibility that I will be quitting my job soon so I need to keep a lot of cash and as a result may pull back on my mortgage payment plan. I like to have 6 months worth of payments in cash during normal times and keep that in an account specifically for the property.
Personally, I think the most important thing for somebody or a couple can do is pay down the mortgage if they own a home. I think this priority even supersedes investing in RRSPs and non-registered investments. Despite the interest, there are ways to pay down sizable chunks of the principal each year. Living a frugal and responsible lifestyle can get you mortgage free faster, and once that occurs, you can plow all your hard earned dollars into investments and for retirement purposes.
Nice post!
Good points. While we're not going out of our way to pay down the mortage sooner, I did at least set it up as accelerated bi-weekly payments which shaves off about 7 years of my term!
Hunh, interesting stuff; it's always nice to learn when you go from paying mostly interest to actually making a dent in your principal. All the more incentive to get the first 34-41% of your loan paid off, I suppose.
Just a note, I included this post in my weekly round-up: http://www.theamateurfinancier.com/blog/weekly-ro… I didn't see a trackback or another method of contacting you.
The interest rates on mortgages are really high and we usually overpay a lot. Once I have calculated the amount I overpay with my mortgage and it was really huge. However, we have nothing to do except taking home loans in order to buy a house as there is no opportunity to buy it for cash. The prices are to high for common people to manage. It's almost impossible to save money as we can't be sure in financial stability and besides, it will take long years for saving the necessary amount. Moreover, prices change almost every day. Well, I think we can't live without loans, however, it's very difficult to get them today due to strict measures provided by banks.
i live in the UK and have reduced my mortgage repayments from £925/month to £427/month in three years. I have achieved this by working very hard and making regular capital repayments. I love the appreciating circle i now find myself in. Now having a disposable £1800 ($2500) per month. This allows me to enjoy life more, and to capitalise my savings, paying further capital re-payments.
Great article. I really enjoy share for my friends and post on my blog.
I know most of the interest gets paid the first 5 years . I am considering refinancing, to make my payments lower each month. I have 30 year fixed now , that i have had for 3 years. If i refinance it starts back at 30. So do you think refinancing is a good thing to do?
Really smart post. I am in the process of paying down my mortgage aggressively. With real estate taxes, it's about 800/month. I pay an additional 860 on top of that. So, I'm on track to pay it all off in about five years after initiating the loan. It is great to get a statement in the mail from Wells Fargo, showing the balance going down. As for other investments, I have a ROTH IRA, which doubles as my emergency savings. I also contribute 10% of my income to a work 401K, with a 7% company match, so I think I'm covered in stocks. I'm using the blog to explore and share ways to pay down the mortgage even sooner, because it's that important to me. Best of luck to everyone trying to do the same…
So, with barely 0 money, how are you able to post? In the library?
Interest is the portion of your monthly mortgage payment that is paid to the bank as a fee for letting you borrow money. At the beginning of your loan, when your balance is at its highest, most of your monthly payment goes towards paying interest.
Did you all know that in some cases if you pay extra on your mortgage, the lender might not apply it to principal unless you specifically ask them to. Often they'll just apply it to future payments so the interest keeps racking up.
There is lots of important information here in this site. Though it looks bit complicated. But it truly has significant contribution to the topic. I told my buddies to go through this regularly. Good job .
This is a fascinating post by the way. I am going to go ahead and save this post for my brother to read later on tonight. Keep up the good quality work.
Thank you Chris, I have heard this as well. You must let the lending institute know to apply the extra $ to principal. I have also heard that a lending institute can charge you for paying the loan off early. Does anyone know about this?
so when your mortgage goes down lets bsay from 200000 to 100000 do you keep paying interest on the 200000 or the 100000. great site by the way.
$400 / month is awesome! Living without an aim is like sailing without a compass. Princess Dress Up games|Barbie Dress Up Games|Nail Games|Hair Games||dress up games|restaurant games|ice cream games||my little pony games
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