Early Mortgage Payoff: How it Actually Works

Hi guys! If you don’t have the means to pay cash for a home, then you’re likely either renting or taking out a mortgage loan to fund a purchase. There’s absolutely nothing wrong with having a mortgage. It’s how most of us were able to get into homeownership. The costs can be high though. There’s the actual down payment that needs to be saved upfront on top of the closing costs required to get the loan. Then, there’s the monthly payment itself (principal and interest) and your carrying costs (insurance, property taxes, maintenance, etc.). Depending on the type of loan that you get, these payments can be with you for a long time – a VERY long time. A common mortgage loan period is a 30-year repayment. Now, I don’t have the expertise to walk you through the various types of loans in detail, but I do know a thing or two about cutting away at that repayment period. There are ways to pay your mortgage off early, and they’re not as complicated as you may think.

Before I decided to buy a home, I was looking at renting. I’d toured a beautiful apartment in a gated neighborhood and was just about ready to sign the lease when my parents suggested that I compare that rent against the monthly cost to buy a home instead. This was back in the 2008 timeframe when the financial crisis had a lot of homeowners underwater, so there was a lot of available inventory and prices were quite good. It turns out that the mortgage payment for the average home prices in my area at that time were actually cheaper than the average price for rent – much cheaper, in fact, than the apartment I was looking at. When I factored in insurance and property taxes, I was still looking at paying less for a home that I’d eventually own than what I would be paying for rent. So, I decided not to rent and started to house hunt instead. It took a long time. I’d been searching for probably nearly a year before I settled on the house that I eventually purchased. In late 2009, I closed on a recently renovated 2 bed 2 bath home in a great neighborhood – perfect for a single woman in her early 20s.

One of the best pieces of financial advice that my mom gave me was to NEVER make just the minimum payment on anything – not even my mortgage. Now, what I’m about to say next is key. Anytime you send an additional payment to a loan, make sure that you specify to the lender that you want that extra money to go toward the principal. I’ve already mentioned that a payment is both principal and interest. The principal is the part of your payment that goes toward paying back the actual amount of money that you borrowed. Interest is the fee charged to you for borrowing money – basically the profit for the lender. Interest does not actually go toward paying the money back even though it’s part of your payment, and it’s usually the bigger portion of your payment in the beginning. The monthly amount of interest on a loan is calculated based on the remaining balance or the total amount of money you still need to pay back. Generally and with fixed interest rates, the lower the balance, the less interest you’ll be charged, which means more of your regular monthly payment will go toward actually paying off the loan. (I’ll show you an example in a minute.) You want as much money going toward principal as possible in order to be charged less interest so that you can pay your loan back as quickly as possible. This frees up your money to do other things and also lowers your monthly expenses. If it doesn’t have to go toward the mortgage (or other bills), it could go toward investments, extra savings, cash flow that new outdoor kitchen, or that 2-week vacation to Jamaica you’ve always wanted to take. So, from my very first monthly payment, I sent at least $100 extra toward the principal every month.

There are a ton of mortgage calculators that you can find with a quick internet search. I don’t endorse any particular one. They all work fine, but for this example, I’m using the Mortgage Payoff Calculator at calculator.net. Using an example of a $150,000 loan at a 5% fixed interest rate for a 30-year repayment period, if you send an additional $100 every month to principal, you’ll pay your loan off in 23 years and 7 months rather than 30 years and save over $34,000 in interest over the life of the loan.

So, as you can see, it doesn’t take much to make a big impact over time.

Now, a little more on the interest we talked about earlier. Let’s look at the amortization schedule (the monthly view of your payment breakdown) for this example. In the table below, ‘Without Payoff’ on the left represents sending only the payment amount listed on your statement, and ‘With Payoff’ on the right represents sending an extra $100 per month to the principal. Notice how the Interest decreases over time but the Principal increases. The interest rate did not change, and the amount of the payment you sent did not change, but you chip away at paying off or paying down the End Balance with each monthly payment that you send. The interest gets lower simply because there’s less End Balance over time to calculate against. So, over time, more of your monthly payment is Principal that goes toward paying off the loan and less is interest. If you send extra Principal on top of your regular monthly payment, you’re making this process happen faster.

Another method that I hear about quite a bit is to contact your lender and arrange biweekly payments. By the end of a year, you’ll end up sending the equivalent of 13 monthly payments instead of 12, which also pays the loan off faster. The payoff time with this method is 25 years and 4 months and a savings of over $25,000 in interest.

Hopefully, this is starting to make sense. The more additional principal payments you’re able to make, the faster you’ll be be able to pay off your mortgage. Let’s see what sending an additional $500 a month would do.

Amazing, right! Paid off in less than half the time and saving over $85,000 in interest over the life of the loan! And remember, these are just examples. Pull out your own mortgage statement (or auto loan statement – it’s the same concept), plug in your numbers, and see what sending a little extra to principal would do for your situation. It doesn’t have to be a lot in order for you to see a difference. You just need to be consistent. Let’s look at what sending an extra $20 a month would look like:

Paid off 1 year and 7 months early with a savings of over $8,800 in interest. Still a win!

I didn’t spend time talking through budgeting basics today, but it’s still sitting at the foundation here. Organizing your budget and assigning a purpose to every dollar shows you what can be categorized as extra mortgage principal as well. I do agree with many of the experts that you should focus on paying off consumer debt and building your emergency fund before you start sending extra principal payments though. I was blessed to have paid off my student loans and my car before having a mortgage, so I was able to start sending extra principal from day one. With no consumer debt, it was not a struggle for me to send an extra $100 every month. Living below your means also helps with this a great deal. When you don’t need every dollar to go toward your four walls (housing, food, utilities, and transportation) and other debt, more money is freed up to do other things like make additional principal payments. Now, my income has not remained the same as it was in 2009. As I made more money over time, I started sending more to my mortgage principal every month too. Now, I have a goal to have my 30-yr mortgage completely paid off within the next 3 years putting me right at the 15 year mark, and I have no doubt that I’ll get there.

And I’m proud of it! I did have to stop comparing myself to others to see the greatness of it though. It’s easy to do a Google search and find stories about other people’s financial success stories and how they’ve buckled down and paid their mortgages off in 5 years flat. I actually started to find it more depressing than reason to celebrate, as shameful as that sounds. I kept wondering what was wrong with me and why I couldn’t do this faster. I didn’t understand then that there’s freedom in just focusing on your own journey sometimes. Now, don’t get me wrong, if you’ve been able to pay off your home in 5 years, I am AMAZED! That needs to be celebrated! You need to be teaching the rest of us how you did it! I used to feel defeated by it though – like I didn’t have what it takes to do the same thing. But what I’ve learned is that my journey is MY journey and yours is yours. I guess they’re like snowflakes. No two are the same. I can rejoice with you now when I hear that you’ve done this amazing money move (cuz, let’s be honest, paying off your mortgage is MAJOR), but I can also rejoice and be proud of myself now too. In the last 6 years, I’ve come from barely having enough to pay the bills after my divorce to being on a solid track to paying off my home 15 years early. That’s major too! ANYTHING that you’re doing to get yourself and your family in a better financial position is MAJOR, and you should be proud! The race is not to the swift or the strong, but to those who endure til the end.