Understanding Your Mortgage and Paying it Down Quickly
A mortgage is a funny thing. It’s a financial instrument that almost everybody has, yet few understand clearly. The masses tend to make general statements about mortgages that have essentially been repeated so many times where they are accepted as common fact.
For instance, renting is throwing away money and paying a mortgage is not. This may or may not be true depending on your situation. If you have a 30-year mortgage, they are extremely front loaded with interest. In fact, for years, almost your entire payment is paying interest to a bank with very little of it going towards paying down the actual principal.
Utilizing mortgage calculators and amortization schedules can help paint a clear picture for you about your current mortgage or a mortgage you’re considering. An amortization schedule breaks out every payment for the entire term of your loan (typically 30 years) showing you how much of that payment goes towards interest, how much goes toward the principal and the resulting balance yet to be paid off.
Let’s look at an example. If you have a 30-year fixed $250,000 loan at 4.5%, for the first year of the loan, you will be paying $15,200.56 in payments – note that this doesn’t include insurance or taxes which significantly increase your costs. Of that $15,200.56 in payments, 26.5% or $4,033.07 of that will go towards paying down your mortgage. The remaining 73.5% or $11,167.49 goes toward interest.
Let’s jump to year ten. Again, you pay $15,200.56 in payments. As you move through the years of your loan, your allocation towards principal goes up and the amount towards interest goes down. In year ten, just under 39.7% or $6,042.21 of the payments goes towards principal and the remaining 60.3% or $9,158.35 goes toward interest.
Let’s then jump to year twenty. Out of the $15,200.56 in payments, 62.3% or $9,468.10 of your payments goes toward principal and the remaining 37.7% or $5,732.46 goes toward interest. As you can see, now more of your money is paying down your mortgage than going to the bank in interest. This increases until the end of your loan when you pay it off completely.
If your aim is to pay down your mortgage quickly, you could say your goal is then to get through the interest-dominated years as fast as possible. Paying extra in the beginning is more impactful than paying extra at the end. The more you pay down early, the more you save in interest for the remainder of your loan.
Again, by playing with the numbers on mortgage calculators and generating amortization schedules, you can see how making extra payments can impact the overall schedule. You can even use the tool when you add extra money to every payment to see how it changes the schedule. For example, if you add $50 to each payment in the example above, you would cut 2 years and 3 months off the 30 year term of the loan and would save more than $18,000 in interest. Not bad for only $50 additional each month.
Understanding your mortgage is an important thing to do for any home owner. Understanding how to impact the interest and principal allocation of each payment and how to pay down your mortgage quickly can make a drastic difference in your overall long-term financial picture. Everyone dreams of having their home paid off, but few understand the best approach to achieve such a goal. Use mortgage calculators and amortization schedules to monitor your progress and find ways to get there as fast as possible.