when putting extra money towards principal on a mortgage, does your monthly payment go down or the term of mortgage?

Jul 10, 2007
12,050
3
0
lets say monthly payment is $1000.
$800 is towards interest, $200 is towards principal on a 30 year fixed, no pre-pay penalty.

now lets say i make monthly payments of $1500 each month, the extra $500 towards principal.
will that lower my monthly payments or just shorten the length of my mortgage?
 

rivan

Diamond Member
Jul 8, 2003
9,677
3
81
Originally posted by: waffleironhead
payments stay the same. You will just have it paid off sooner.

And if you're early in the term, you'll save LOADS on interest.
 

dullard

Elite Member
May 21, 2001
25,214
3,632
126
Fixed loan: monthly payments will stay the same. The amount of each payment going to interest will drop, and the amount going to principal will rise. All future payments will therefore have extra principal. Thus, a small extra bit towards principal now has an escalating snowball effect of drastically shortening the mortgage length.

Variable loan: monthly payments will stay the same as with fixed until the loan varies (often once a year). Then monthly payments will be adjusted according to the terms of your mortgage.
 
Jul 10, 2007
12,050
3
0
Originally posted by: rivan
Originally posted by: waffleironhead
payments stay the same. You will just have it paid off sooner.

And if you're early in the term, you'll save LOADS on interest.

hmm... so you have control, to a certain extent, to shorten the length of the term.
technically, i can turn a 30 year into for instance, a 20 year if i put more towards principal every month.

is there a strategy as to how to maximize the benefits of pre-paying?
e.g., how much extra to put each month (as much as possible), do it every month, lump sum once a year, etc.
 

markgm

Diamond Member
Aug 23, 2001
3,290
1
81
Maybe not in this economy, but you're better off throwing the extra money into some sort of investment.
 

dullard

Elite Member
May 21, 2001
25,214
3,632
126
Number time: A $178,545 mortgage at 5.38% fixed interest will be 30 years with $1000/month payments and $800 going to interest on the first month.

If you paid $1000/month, it'll last 30 years and you'd pay $1000*360 = $360,000.

If you paid $1250/month every month, it'll last ~19 years and you'd pay $1250*~228 = $285,655.

If you paid $1500/month every month, it'll last ~14.2 years and you'd pay $1500*~170 = $255,715.

And add in taxes/insurance to these monthly numbers and total payments of course.
 

MixMasterTang

Diamond Member
Jul 23, 2001
3,167
176
106
Originally posted by: BlahBlahYouToo
Originally posted by: rivan
Originally posted by: waffleironhead
payments stay the same. You will just have it paid off sooner.

And if you're early in the term, you'll save LOADS on interest.

hmm... so you have control, to a certain extent, to shorten the length of the term.
technically, i can turn a 30 year into for instance, a 20 year if i put more towards principal every month.

is there a strategy as to how to maximize the benefits of pre-paying?
e.g., how much extra to put each month (as much as possible), do it every month, lump sum once a year, etc.

The more often you overpay the more often you will save on interest. But also you have the option of investing that money and if you recieve a rate of return on your investment that is greater than the interest you are paying on your home loan it could prove to be a better financial move.
 

puffff

Platinum Member
Jun 25, 2004
2,374
0
0
Originally posted by: BlahBlahYouToo
Originally posted by: rivan
Originally posted by: waffleironhead
payments stay the same. You will just have it paid off sooner.

And if you're early in the term, you'll save LOADS on interest.

hmm... so you have control, to a certain extent, to shorten the length of the term.
technically, i can turn a 30 year into for instance, a 20 year if i put more towards principal every month.

is there a strategy as to how to maximize the benefits of pre-paying?
e.g., how much extra to put each month (as much as possible), do it every month, lump sum once a year, etc.

Think of prepaying as locking in an investment at your mortgage rate. If you're paying 6% interest, and you prepay $500, you've locked in a $500 investment at 6% for 30 years (or however many years are left on your mortgage). If you begin prepaying 15 years into your mortgage, you're locking in a 6% investment for 15 years. There's really no strategy. You're getting 6% on every dollar you prepay.

If you've got a really low interest rate on your mortgage, you might be better off investing that money somewhere else. That would depend on your tolerance of risk vs reward.

Edit: I'm leaving out tax benefits for your interest payments, but in general, I think this is a good way to look at it.
 

dullard

Elite Member
May 21, 2001
25,214
3,632
126
Originally posted by: BlahBlahYouToo
hmm... so you have control, to a certain extent, to shorten the length of the term.
technically, i can turn a 30 year into for instance, a 20 year if i put more towards principal every month.

is there a strategy as to how to maximize the benefits of pre-paying?
e.g., how much extra to put each month (as much as possible), do it every month, lump sum once a year, etc.
Yes, you can shorten a loan. That is why it often is better to get a longer loan term even if you can afford a shorter term. Then just make the larger payments when you can. It gives you flexability to pay less when you can't afford it. But, if the bank gives you an incentive to take a shorter term (lower interest rate), then that might tip the balance to just take the shorter term at the start.

If you are paying say 5.5% interest, think of prepaying as an investment. What ever you prepay you'll get 5.5% back, guaranteed. The earlier you prepay, the sooner you'll start the 5.5% growth. Of course, this does have modest tax consequences. But a 5.5% guaranteed return on your investment is a nice part of a person's investment portfolio. It sure beats a 3% CD return or even most money market returns. With the stock and bond markets flat to down, you may even beat those returns in the short term.

So invest in your house whenever a guaranteed 5.5% return (or whatever your interest rate is) fits well with your balanced (stock/bond/real estate/others) investment portfolio.
 

spidey07

No Lifer
Aug 4, 2000
65,469
5
76
Originally posted by: BlahBlahYouToo
ok, so it sounds like the strategy is pretty obvious.
pay early and pay often to maximize benefits, lol.

No. The strategy is to invest that money and beat your rate increasing your overall net worth and that worth being liquid and not locked into your house.

Most of the time paying extra principal is throwing money away. You'll just have to run the numbers to see what's best for you, but rarely is paying extra a wise move.
 

thomsbrain

Lifer
Dec 4, 2001
18,148
1
0
Originally posted by: BlahBlahYouToo
ok, so it sounds like the strategy is pretty obvious.
pay early and pay often to maximize benefits, lol.

But that's only true if you don't think you could do better on the stock market with the extra money. If you average 8% on the market with that money, you'd have more money in the long run by NOT paying your mortgage off early. It's about your tolerance for risk.
 

markgm

Diamond Member
Aug 23, 2001
3,290
1
81
Invest or pay off mortgage early. I tried to use conservative numbers here.

Assume an average return 8%
Assume a mortgage of $150,000, 30 years, fixed, at 5.5%
You have $2000 to use.

Your mortgage payment is $851.68 a month. That's $306,604.80 over 30 years.

Prepay mortgage, then invest
You therefore have an extra $1148.32 a month to apply towards your mortgage.
You'll pay off your mortgage in 7 years and 10 months. After which you'll have $2000 a month to invest for 22 years and 2 months. You'll have paid $184,223.51 over the course of your mortgage, "saving" $122,381.29 in interest.

After 30 years you'll have your house paid off along with an investment worth $1,460,924.95






Pay mortgage for 30 years, invest for 30 years.
If you follow this plan you'll pay $851.68 each month for 30 years and invest $1148.32 each month for 30 years.

After 30 years you'll have your house paid off along with an investment worth $1,685,906.49

By not prepaying your mortgage you earned an extra $224,981.54.



None of this even takes into account that you can claim the $156,604.80 you paid in interest over the course of your loan on your income tax return.

 

tidehigh

Senior member
Nov 13, 2006
568
0
0
although i generally agree investing is better than paying off early, you aren't accounting for income tax on the investment, either.

or capital gains tax, or whatever it may be.
 

markgm

Diamond Member
Aug 23, 2001
3,290
1
81
Good call on capital gains, though if you have a mortgage you might be able to get some of that money back, here are the numbers paying 15% long term capital gains tax. You still come out ahead with an extra 9.3% by not paying your mortgage off early. You can of course avoid this hit by putting more into your 401(k) or a Roth IRA.

Invest or pay off mortgage early. I tried to use conservative numbers here.

Assume an average return 8% with 15% capital gains tax.
Assume a mortgage of $150,000, 30 years, fixed, at 5.5%
You have $2000 to use.

Your mortgage payment is $851.68 a month. That's $306,604.80 over 30 years.

Prepay mortgage, then invest
You therefore have an extra $1148.32 a month to apply towards your mortgage.
You'll pay off your mortgage in 7 years and 10 months. After which you'll have $2000 a month to invest for 22 years and 2 months. You'll have paid $184,223.51 over the course of your mortgage, "saving" $122,381.29 in interest.

After 30 years you'll have your house paid off along with an investment worth $1,242,707.86







Pay mortgage for 30 years, invest for 30 years.
If you follow this plan you'll pay $851.68 each month for 30 years and invest $1148.32 each month for 30 years.

After 30 years you'll have your house paid off along with an investment worth $1,341,132.98

By not prepaying your mortgage you earned an extra $98,425.12.



None of this even takes into account that you can claim the $156,604.80 you paid in interest over the course of your loan on your income tax return.
 
Jul 10, 2007
12,050
3
0
Originally posted by: spidey07
Originally posted by: BlahBlahYouToo
ok, so it sounds like the strategy is pretty obvious.
pay early and pay often to maximize benefits, lol.

No. The strategy is to invest that money and beat your rate increasing your overall net worth and that worth being liquid and not locked into your house.

Most of the time paying extra principal is throwing money away. You'll just have to run the numbers to see what's best for you, but rarely is paying extra a wise move.

ok, let me rephrase.
for someone who does not plan to invest (or does not actively manage any investments; all i have are index funds and given the current market and economy will not be pumping more money into it), it makes sense to pay more and if so, it makes more sense to pay early.
 

markgm

Diamond Member
Aug 23, 2001
3,290
1
81
Common wisdom is that over the long term, the stock market will pay a 10% return on your investment, which in turn is what your index fund attempts to match. I went with 8% to be conservative. If you're okay with at least 9.6% less money at retirement, with less time to let the market work for you, afraid of taking any risk, then yes, it makes sense to pay more on your mortgage.

When the economy is tanking is when you should feel the best about investing. Things are cheap. When things are doing well it's already too late. I don't try to guess the market, I just put 26% of my salary into a Roth IRA, my 401(k) and an index fund and I'll check back in 20 years to see if I can retire.
 

Strk

Lifer
Nov 23, 2003
10,198
4
76
Originally posted by: CaffeineAndStuff
If you have an Interest Only loan then it will reamortize automatically and your payment next month will be lower.

Do all companies do that or is it lender specific? If so, I wasn't aware they did that automatically.
 

dullard

Elite Member
May 21, 2001
25,214
3,632
126
Originally posted by: markgm
Common wisdom is that over the long term, the stock market will pay a 10% return on your investment, which in turn is what your index fund attempts to match. I went with 8% to be conservative. If you're okay with at least 9.6% less money at retirement, with less time to let the market work for you, afraid of taking any risk, then yes, it makes sense to pay more on your mortgage.

When the economy is tanking is when you should feel the best about investing. Things are cheap. When things are doing well it's already too late. I don't try to guess the market, I just put 26% of my salary into a Roth IRA, my 401(k) and an index fund and I'll check back in 20 years to see if I can retire.
Your attitude and strategy are correct. However, few experts are expecting an annual return of 10% anymore. That 10% number included years when dividends were about 2%-3% higher than they are today. Sure, we may do quite well and do far better than 10%. That is especially true if the stock market tanks and you start from the new low bottom.

But, look at the long term picture. Stock market gains have been nil over the last decade for any investment that you had a decade ago (Note: you still did get the drastically reduced dividends so it wasn't exactly flat). What I mean is what are the 10 year or even 15 year returns for funds? As you mention, 10% (or better) has occured for some funds. But less than 10% is more typical. For example, https://personal.vanguard.com/us/funds/vanguard/index">Vanguard</a> is popular due to their low fees. I linked their index funds as you suggested buying. What are their 10 year and longer returns?

Fund from top to bottom of link, 10-year return, lifetime return
1) 5.24%, 5.51% (14 years)
2) 6.48%, 6.76% (14 years)
3) 5.78%, 6.98% (21 years)
4) 6.96%, 7.60% (14 years)
5) 5.02%, 8.61% (15 years)
6) 3.43%, 11.55% (32 years)
7) ----, 4.46% (2 years)
8) ----, negative 2.09% (8 years)
9) 2.47%, 8.91% (15 years)
10) ----, negative 2.45% (1 year)
11) ----, 6.24% (4 years)
12) 3.89%, 9.67% (16 years)
13) 4.51%, 10.37% (15 years)
14) 5.35%, 11.18% (20 years)
15) ----, 7.17% (1 year)
16) ----, 9.69% (10 years)
17) ----, negative 0.74% (1 year)
18) ----, 6.72% (10 years)
19) 5.70%, 10.71% (47 years)
20) ----, 7.30% (10 years)
21) 10.51%, 12.79% (12 years)
22) ----, 4.98% (8 years)
23) 12.96%, 10.15% (14 years)
24) 6.67%, 10.18% (18 years)
25) ----, 5.42% (1 year)
26) 5.35%, 2.13% (18 years)
27) 7.04%, 7.00% (12 years)
Median lifetime return of the 27 Vanguard index funds: 7.17%.
Average lifetime return of the 27 Vanguard index funds: 6.92%

There are the index funds. Of 27 of them, only 7 beat 10% lifetime returns (and they just barely beat 10%). Note: the best lifetime there 12.79% was the real estate fund that is tanking right now, so that 12.79% isn't going to last.

Now consider that the baby boomers are going to stop contributing in the next couple of years and start withdrawing from the stock market. Combined with cut dividends, the 10% number is just not a realistic estimate any more. Your 8% number was ok and is what many experts use, but it wasn't conservative.

For a diversified portfolio (a good thing), you need some stable investments. Typically bonds are recommended. Bonds do carry risk (especially bond funds) and their return isn't that great. Moving some of your bond money into a guaranteed return on your debts is something worth considering. And if your mortgage (or other debt) is 6% or higher, it is doubly worth considering doing so. Still invest in stocks that will likely return closer to 8%. But, don't exclude stable nearly risk-free returns.
 

rasczak

Lifer
Jan 29, 2005
10,453
22
81
Originally posted by: BlahBlahYouToo
Originally posted by: rivan
Originally posted by: waffleironhead
payments stay the same. You will just have it paid off sooner.

And if you're early in the term, you'll save LOADS on interest.

hmm... so you have control, to a certain extent, to shorten the length of the term.
technically, i can turn a 30 year into for instance, a 20 year if i put more towards principal every month.

is there a strategy as to how to maximize the benefits of pre-paying?
e.g., how much extra to put each month (as much as possible), do it every month, lump sum once a year, etc.

be carefule with this though, usually mortgage companies have a clause where you can only put in only an extra $$$ amount for the year. after that you may go into prepayment penalties.
 

Dirigible

Diamond Member
Apr 26, 2006
5,961
30
91
Originally posted by: spidey07
Originally posted by: BlahBlahYouToo
ok, so it sounds like the strategy is pretty obvious.
pay early and pay often to maximize benefits, lol.

No. The strategy is to invest that money and beat your rate increasing your overall net worth and that worth being liquid and not locked into your house.

Most of the time paying extra principal is throwing money away. You'll just have to run the numbers to see what's best for you, but rarely is paying extra a wise move.

This is a huge point. You pay your mortgage early and it's awfully hard to access that money if you need to. Investing in stocks or whatever has a liquidity advantage.

Compare your return on paying your mortgage early v. expected returns from other investments. For me, paying the mortgage off early would have to be a clear winner. If it's only slightly better, the liquidity concerns means I'm not doing it.

 

ponyo

Lifer
Feb 14, 2002
19,689
2,811
126
The way I look at it is you're getting 100% minimum guaranteed return if you pay extra to your mortgage. Stock market or other investments are not guaranteed and your return may or may not exceed it.

You can look at numbers but numbers are not everything. I don't know if you can put a price on not having a house payment. It's really liberating feeling and one less worry in life. If you can pay off your house while you're young, you have your whole life front of you.

People can debate numbers and try to guess future returns but one thing I know is every rich people I know own their house free and clear. That's something that stuck with me and motivated me to pay off my house early. I can tell you first hand that not having a mortgage is heaven, and I love every second of it.
 

rivan

Diamond Member
Jul 8, 2003
9,677
3
81
Originally posted by: Naustica
The way I look at it is you're getting 100% minimum guaranteed return if you pay extra to your mortgage. Stock market or other investments are not guaranteed and your return may or may not exceed it.

You can look at numbers but numbers are not everything. I don't know if you can put a price on not having a house payment. It's really liberating feeling and one less worry in life. If you can pay off your house while you're young, you have your whole life front of you.

People can debate numbers and try to guess future returns but one thing I know is every rich people I know own their house free and clear. That's something that stuck with me and motivated me to pay off my house early. I can tell you first hand that not having a mortgage is heaven, and I love every second of it.

Exactly - someone else mentioned your tolerance for risk - my tolerance is rather low, and I choose to prepay my mortgage whenever possible.
 
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