You’ve taken out a loan to buy a home or you’re considering borrowing money, but the thought of carrying the weight of a mortgage payment for 30 years, the typical length of a mortgage, is feeling daunting. But, what if you paid more than your monthly payment? Where would that get you? Well, if you have a Simple Interest Mortgage, you could see the amount of interest paid shrink and the length of your mortgage shorten.
Say you took out a $150,000 loan at 5% interest. The monthly payment would be $805 and you would eventually pay $139,884 in interest for the length of the loan. Yikes! That’s a big number, but keep in mind that is over 30 years and very few people stay in a home that long.
Now, what if you added $200 to your payment? You’ve just shortened your loan to 19 years and your interest has shrunk to $85,035 (a 39% decrease). That’s looking a bit better, isn’t it?
Want to calculate for a different amount? This calculator from SmartMoney will show you how much money you can save and how many years you can cut off from a mortgage by making higher or extra payments.
But here’s the catch – You need to make sure you have a mortgage that allows for prepayments and isn’t a monthly accrual plan. Simple Interest Mortgages (SIMs) accrue interest daily. Some banks will accept a payment early, but will only apply the payment after the monthly interest has accrued. They basically hold the money you send until they’re sure they have made their money. Make sure you ask your lender if prepayments or paying extra each month is allowed.
If you’ve had a monthly accrual mortgage for a while, it’s also possible that your mortgage holder has converted it to a SIM to make more money. They can do that if it was included in the writing of the original loan agreement. You can check with them to see if that’s the case. If it hasn’t been converted, it doesn’t hurt to ask if it’s possible for them to do so.
You also need to consider if the higher or extra payments are worth any financial strain they might put on you. Could the extra money be better spent somewhere else? Or should it be invested or put into savings for later milestones, like your child’s college? It’s important to weigh all your options, including future ones.
Have a question about choosing a mortgage and prepaying, or need a referral for a good lender, give us a call at 910-202-2546 or email us through our Contact page.