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loan blocksWhen considering which kind of mortgage to you want, a 15-year mortgage has a lot of upsides. You will, after all, eliminate your house payment in half the time. The downside to a 15-year is that you’re committed to a higher monthly payment, even if your financial situation changes. 

Because of this, many borrowers decide to go with a 30-year mortgage option in order to safeguard against the future. The good news is that you don’t have to take 30 years to pay off your mortgage just because you chose the 30-year option. Paying a little extra to the principal each month can reduce the term length on your mortgage and allow you to pay off your mortgage early.

How Does it Work?

Your monthly mortgage payment consists of principal and interest. As the principal balance on your loan goes down over time, the interest portion of the payment lowers, leaving more of your payment available to put toward the principal. When you pay more than the monthly amount due for your mortgage payment, the extra funds can be put directly toward the principal balance on your loan. This saves you money on your mortgage in two ways:

 

  • 1. Reduce the repayment term: The extra money put toward your principal is tacked on to the end of your loan and covers the furthest payment out. That means that when you get to that point in the loan, your payment will already be taken care of.
  • 2. Reduce the interest due: The interest that is charged on a mortgage is a percentage of the principal balance. Reducing the amount of the principal reduces the amount of interest charged. This is where you really save money.

 

Each time you pay the principal on your mortgage, you reduce the balance that can be charged interest on. This reduces your principal amount, reduces your mortgage payment, and increases the portion of each payment that is applied to the principal. The cycle of interest reduction continues each time you pay extra principal until you have saved a significant amount of money on the life of your loan.

How Much More Do You Need to Pay to Make a Difference?

Any extra funds that you can put towards the principal on your mortgage will compound and save you money in the long run. One good habit is to round up your monthly mortgage payment. If your monthly payment is $644, pay $650 every month. In your mind, you were probably already thinking of the payment as $650 anyway, and the extra $6 won’t make any difference to you. The savings over the course of time is fairly significant, though. On a $200,000 mortgage, with a 30-year term, the extra $6 per month will save your four payments at the end of your mortgage.

If you can make a higher contribution to your principal mortgage balance each month, you will see more dramatic results. Those who double their mortgage payment or pay an extra $1,000 per month can pay off their mortgage faster than they would with a 15-year mortgage in many cases. Even committing to $100 extra per month will make a huge difference. On a $200,000 loan, an extra $100 per month put toward the principal will result in the loan being paid off 5 years and 2 months early, and save $37,069.75 in interest.