Understanding Accelerated Mortgage Payments
For the average homeowner, paying off your home loan takes time. It’s a commitment. For those with a 30 year fixed rate mortgage it’s a 30 year commitment. However, there is a way to quicken the process. Accelerated mortgage payments can speed up repayment and save you a lot of cash.
Your Mortgage Payment
Your monthly mortgage payment consists of two parts. You are making a payment toward your principal and making an interest payment. The principal is the outstanding balance of your mortgage. It is the amount you borrowed from your lender in order to purchase your home. The interest is essentially the monthly fee you pay to the lender for loaning you money. You pay this fee until you've paid back your borrowed money entirely. The interest is a percentage that is set at closing. Over the lifetime of the loan that interest payment can amount to tens of thousands of dollars. The interest is what people commonly refer to as your mortgage rate. Currently, mortgage rates are near historic lows.
Most mortgages are fully amortized. This means that every month the ratio of principal to interest will change but the payment will remain the same. The percentage of interest you are paying remains steady on a fixed rate loan. However, the dollar amount gets smaller because as you are paying on the principal the amount owed gets smaller.
Let’s say, for example, you borrow $300,000 with an annual interest rate of 3%. For that 30 year fixed rate loan your monthly payment for mortgage plus interest would be approximately $1,265. Since your annual rate is 3%, divide 3% by 12 months and you’ll get 0.25%. Every month you will pay 0.25% interest on your principal. So, for the first month 0.25% of $300,000 or $750 of your $1,265 is going toward interest. The remaining $515 would be your principal payment. The following month you would be paying 0.25% interest on $299,485 because your principal decreased. This trend of paying more in principal and less in interest continues for the entirety of your 360 monthly payments.
What Are Accelerated Mortgage Payments?
Increasing your principal payments can help you achieve early loan repayment and save you in interest costs. Increasing the frequency of your payment or the amount you pay toward your principal can have some surprising effects. Accelerated Mortgage payments are typically handled in one of two ways.
Biweekly Payments
With a biweekly payment system you save money in interest by increasing your mortgage payment frequency. For this, you essentially pay half your mortgage payment every two weeks. In one year (52 weeks), you’ve made 26 half payments or 13 full payments instead of 12 full payments. Additionally, you are basically paying two weeks ahead. This saves interest and you’ve accelerated your mortgage repayment.
Additional Principal Payments
Your mortgage provider will allow you to make additional payments directly toward your principal. By paying that extra payment you knock a few years off your mortgage. Let’s use the example above and say you have a $300,000 loan with an annual interest rate of 3%. Let’s also say for this example that you pay an additional $100 on top of your $1,265 monthly payment. That $100 overpayment would save you $19,997 in interest over the course of the loan. The larger the amount you pay toward your principal, especially early on, the less you pay in interest. In this accelerated mortgage payment example, you would also pay off your home loan 41 months sooner.
Prepayment Penalties
Your lender may charge a prepayment penalty on your conventional loan. These fees can be acquired if you pay too much of principal or pay it too quickly. Read the fine print on your loan agreement or contact your lender about prepayment penalties in regards to your loan. When considering accelerated mortgage payments it is important to understand your prepayment penalties. There is no standardization to these fees. A contract with high prepayment penalties may make accelerated mortgage payments less than appealing for your specific loan.
Bottom Line
Your lender collects interest until the entirety of your principal has been paid back. Paying back your principal early can save you lots of money in interest. Accelerated mortgage payments may help you pay off your home loan faster and for less. Understanding the specifics of your loan can help you in determining whether accelerated mortgage payments are a viable option for you. Contact us if you are interested in trying to find a mortgage that works for you. The professionals at Peoples Choice Mortgage are here to educate you about all of your loan options.