Add a little bit to your mortgage payment each month as an “extra principal payment” and shorten the life of your loan.
Imagine the amortization of your 30 year mortgage as a board game—360 equal payments. You travel across the board step–by–step, payment–by–payment until you reach the finish line – no mortgage! Each step has two parts, principal and interest. The goal is to jump forward more than one space at a time. If you can propel yourself forward on the board, skipping spots along the way, you can also skip the interest for the spots you jumped. This approach can save you thousands of dollars over time. As an added bonus, each time you pay extra toward your mortgage, the ratio of interest–to–principal for each payment changes—in your favor!
Why it works:
At the beginning of your mortgage, the principal part of your payment is relatively low while the interest portion is relatively high. For example, at current interest rates on a 30 year fixed rate mortgage, the beginning ratio of a monthly payment is 67% interest to 33% principal. The ratio of interest to principal changes with each payment. Gradually, less of your monthly payment is applied toward interest, and more is applied toward principal. On a current 30 year fixed rate mortgage, the 50/50 point occurs somewhere after year 11, but this figure can vary from year 3 to year 28, depending on the interest rate of your loan. As you near the end of the mortgage, the ratio reverses, and the payment is made up primarily of principal.
What to do:
Take your current monthly payment, and divide it by 12. (As an easy example, a $1200 monthly payment divided by 12 equals $100.) Take that amount ($100 in our example), and add it to your monthly mortgage payment.
TIP: Be careful to designate the extra payment as “additional principal” when you send it to your lender. As long as your mortgage payments are current, your lender will apply the extra payment to your principal balance.
Each prepayment will move you forward on the game board that we mentioned above. And every time you move forward you will save more interest that you would have paid to your mortgage company.