When you take out a mortgage to buy a home, you’ll likely be presented with an amortization schedule that shows how your payments will be applied to the loan over time.
Understanding how amortization works is crucial to making informed decisions about your mortgage.
One strategy that can have a big impact on the overall cost and timeline of your loan is making extra payments.
How do extra payments affect amortization
When you make extra payments on your mortgage, you’re essentially paying down the loan balance faster than the schedule dictates.
This can have a big impact on the amount of interest you’ll pay over the life of the loan.
This is because the majority of your early mortgage payments are applied to interest rather than principal.
For example, let’s say you have a 30-year fixed-rate mortgage for $300,000 at an interest rate of 3.5%.
According to an amortization table calculator, your monthly payment would be $1,347 and you would pay a total of $483,139 over the life of the loan, with $183,139 of that paid towards interest.
Now let’s say you decide to make an additional $500 payment each month.
According to the calculator, this would reduce the loan term to just over 22 years and save you $86,095 in interest.
That’s a significant reduction in the overall cost of the loan, and it’s all thanks to the power of extra payments.
Strategies for making extra payments
There are a few different strategies you can use to make extra payments on your mortgage, each with its own pros and cons. Some options include:
- Lump sum payments: This involves making a one-time payment of a certain amount, such as a bonus or tax refund, to pay down the loan balance. This can be a quick and easy way to make a big impact, but it requires having a large sum of money available at one time.
- Increasing the frequency of payments: Instead of making one monthly payment, you could make bi-weekly or even weekly payments.This can add up to an extra payment per year, and can be a convenient option if you’re paid on a more frequent schedule.
- Increasing the amount of regular payments: This involves making payments that are slightly higher than the scheduled amount each month. This can be a suitable option if you have a consistent income and can afford to make slightly larger payments each month.
Before making extra payments, it’s wise to consider the terms of your mortgage and your financial situation.
Some mortgages have prepayment penalties, which can negate the benefits of making extra payments.
Additionally, if you’re having trouble making your regular payments or have other high-interest debt, it may be more beneficial to focus on paying that off before making extra payments on your mortgage.
Making extra payments on your mortgage can be a powerful way to save money on the overall cost of your loan.
However, it’s imperative to carefully consider all factors before doing so.
By understanding how amortization works and exploring different strategies for making extra payments, you can make an informed decision about how to most effectively use this strategy to reach your financial goals.