Who else loves playing with the amortization calculator on your mortgage servicer’s website to see how much you could save by paying a little extra each month?
Every month when I go through our finances, I take a look at the calculator for our two mortgages. It’s amazing to watch compound interest in action as you experiment with numbers in the calculator!
Keep reading to learn how I decide when and what to pay extra, and how I’ve been able to keep it up even when the rest of the budget feels tight.
Primary mortgage
Our primary mortgage is for our home that we bought in 2017 and refinanced in 2020. It’s a 15-year mortgage with a 2.375% interest rate. We currently owe $121,900 and are set to pay it off by December 2032 if we just stay the course.
And that’s exactly what we plan to do with that mortgage. Several years ago, we wanted to pay off the house early and worked toward that for a time, but right now our plan is just stay the course on the mortgage for our primary residence.
It doesn’t make financial sense to pay this mortgage off early, as the interest rate is so low. Right now a high-yield savings account will earn over 4%, so it would be a better financial move to put extra funds there than toward this mortgage.
Second mortgage
Our other mortgage is a second mortgage that we used to buy an investment property last year. The initial total of the loan was $310,000 with a 6.65% interest rate and a term of 20 years. We currently owe $300,587 with a maturity date of August 2045.
The loan amount included the purchase of the property plus roughly an extra $100k to to put toward the demolition of the existing home (details here) and the purchase and transportation of another manufactured home to the property. We put the $100k in a high yield savings account to earn interest until we were needed it.
I love playing with the amortization calculator for this second mortgage. It’s so fun to see what a difference even a small extra payment would make.
Effect of extra principal payment on our loan
Here are a couple of scenarios for a consistent extra principal payment each month on our second mortgage.
$50/month
- Saves $10,564 in interest
- Knocks 10 months off the loan
$100/month
- Saves $20,119 in interest
- Knocks 1 year 7 months off the loan
$200/month
- Saves $36,756 in interest
- Knocks 2 years 9 months off the loan
$500/month
- Saves $73,166 in interest
- Knocks 5 years 7 months off the loan
$1,000/month
- Saves $109,697 in interest
- Knocks 8 years 5 months off the loan
Right now we have a lot going on financially (you can read about some of that here), so paying this loan down is not at the top of our priorities.
Still, I am fascinated and motivated by the effect of even a small effort in this area.
So I made a plan.
My plan to make extra principal payments possible
We aren’t allocating any of our normal budget to pay extra on the mortgage for our investment property, but what if I got money outside of our normal budget?
Of course this is money that wouldn’t otherwise be invested. This is money that otherwise would just be sitting, in the form of stuff, in our garage or closets, like it has for years.
Selling stuff online on eBay or Mercari or locally on Facebook Marketplace is not my favorite way to earn money. It’s hard to get motivated to take pictures and type up descriptions when there is so much else that is vying for my time. Still, it’s a legitimate way to earn extra money.
I decided that I was excited enough about the prospect of saving interest on our second mortgage that I would be motivated to sell our stuff online. I set up a $200 recurring payment of extra principal each month. Each month I will aim to sell at least $200 worth of stuff online. I started out with a couple of month’s worth of extra payments in an account.
It really is a win-win. We get rid of stuff that is just sitting around and save money and time on our mortgage as well.
Of course we can always pause these extra payments if something comes up or if we run out of things to sell.
If we continue with $200/month extra payments, we will save over $36,000 and more than 2 and a half years on our loan.
And if we don’t continue with that amount, everything that we have already contributed will still make a difference. So far we’ve done two of these extra $200 payments. According to our mortgage dashboard, that will save us $997 in interest even if we make no other extra payments.
Benefit of paying extra principal at the beginning of a loan
If you’ve ever looked at the amortization schedule for a mortgage, you’ve probably noticed that in the beginning, most of the monthly mortgage payment goes toward interest and very little goes toward principal.
For example, our upcoming payment for November for our second mortgage (investment property) looks like this:
$2,339 payment = $1,666 interest + $673 principal
Each month a little less goes toward interest and a little more goes toward principal. Over time they switch places and the majority of each payment goes toward principal and a small portion toward interest.
Here’s the example of our upcoming payment for November for our primary mortgage (family home):
$1,791 payment = $241 interest + $1,550 principal
When we reduce the principal, interest is being charged on a smaller amount. The sooner we reduce the principal that we’re paying interest on, the sooner we enjoy paying less interest. If we put extra toward our principal today, and spend 25 years paying the rest of the loan, we enjoy 25 years of smaller interest payments. If we made the same extra principal payments 20 years from now, we would have only five years of smaller interest payments. Every payment with a smaller principal saves interest, so we can maximize that saved interest by paying less early in the mortgage when there are a lot of payment left.
Every case is different
Paying extra on your mortgage doesn’t always make financial sense. Our primary mortgage is a perfect example. If we’re looking just at the numbers, it would make more sense to put any extra money into a high yield savings account or buy bonds, both very safe options that will earn more than what you would save paying off your loan early. Our interest rate is even lower than inflation!
Still, some may prefer to not look at the numbers and choose to pay off a low interest mortgage because their priority is to be mortgage-free.
That’s totally fine! Personal finance is personal, after all!
In the case of our investment property, the interest rate is higher. Any extra principal we pay is equivalent to earning a 6.65% return on the extra payment. That’s how we can spend just $200 a month on principal and save over $36,000 on interest!
So what should you do?
Your details will be specific to you, and of course the choice is yours, but here are a few general rules:
If your mortgage interest rate is higher than what you earn on your available cash investments, paying extra on the mortgage principal makes sense. Your mortgage counts as an investment. If you have cash earning 4% interest and are paying 6% interest on a mortgage, every month you are at a net loss of 2% on those transactions. If you had two savings accounts that could earn either 4% or 6%, you’d put your money in the 6% account. Paying down a higher-cost loan has the same effect on your finances.
If you have a mortgage and another loan (whether it’s a student loan, a credit card, or another consumer loan), pay the loan with the higher cost first. Any extra cash goes to the most expensive loan, and you save the most interest overall. Another option is to pay the smallest loan off first, to get a quick win and build momentum. Whichever approach you take, your mortgage is hopefully at a lower rate, and probably larger than, any other loans. Focus on the more expensive loans with smaller balances first. Paying extra principal early on those loans will make even more difference than paying down the mortgage principal early.
If your mortgage rate is below 4%, you might have options that can earn you more than you pay on your mortgage. Right now high yield savings accounts are a good, safe investment, but interest rates are always changing, so pay attention in case they drop again. Still, even if there is an account that is guaranteed to earn more than your mortgage costs, there are some huge benefits to just being entirely free of any debt, so if you decide to pay off a low-interest mortgage just because you want to be debt free, that’s your perogative!
Everyone’s situation is different and personal finance is personal! You’ve got this!
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