Paying $100 on my mortgage today saved me an extra 20%!
I sent an extra $100 towards the principal of my mortgage and you won’t believe what I’m about to share with you. It’s no surprise that paying extra on a mortgage will save interest but have you ever looked at the rate of return? It’s better than the stock market, safer than gold, and makes savings accounts look really pitiful!
My recent experiment
We are 9 years into our 15 year mortgage and have been sending a little extra towards the principal here-and-there. This month we sent an additional $100 towards the principal. There are two benefits in doing this:
1) It chops $100 off our final month’s payment
2) It saves us from paying interest on $100 in principal over the remainder of the loan
Here’s the math
Our final payment was scheduled to be made in March 2016 and would have only been $641.12. Most people would think that paying an additional $100.00 towards the principal would make the final payment $541.12, but that’s the easy math. The actual benefit of sending that extra dough is $120.64. That’s at 20% return! Well not really, but it’s better than what I can get in a savings account.
It’s kind of like compound interest backwards
Each dollar I send ahead of time saves me in interest next month. Because I keep sending the same amount of money to the mortgage I will be able to put even more towards the principal, which reduces the amount of interest due the next month, which allows me to put more of the payment towards the principal, which reduces interest, etc. etc. etc… Here are the actual numbers:
Before extra principal payment:
$1,100.13 (monthly principal and interest payment)
$198.76 (amount of monthly payment that goes towards interest in July 2012)
$901.37 (remaining amount of payment which would be applied to principal)
After extra $100 is thrown at the principal:
$1,100.13 (same monthly payment for principal and interest)
$198.31 (interest portion)
$901.82 (principal portion)
It doesn’t look like much, only a difference of 45 cents, but that’s just this month. The accumulation of money saved over the life of the loan is the real savings.
What if I did this 5 years earlier?
Check this out: Had I sent the $100 in 2007 instead of 2012 I would have reduced the final payment by $158.45. That’s a 58% return on my investment! What if I had $1,000 to send back then? Not only would it save me almost $600 in interest but we would pay off the loan an entire month earlier! Let’s see, $594.57 saved in interest plus one less month to pay ($1,100.13) is $1,694.70 less to send to the bank! I’m extremely close to a 70% return in that scenario!
Paying it off early
Are you excited? I am! Paying off our house has been a goal of mine since we signed the papers. Don’t be misled by the arguments people give about keeping a home mortgage around. Every time you put money towards the principal you are accellerating your debt free date! If you are on the fence about sending extra towards your mortgage then ask yourself this question: “What would I do with a mortgage payment if I didn’t have a mortgage?“
That’s awesome! I think the key thing is to ensure your extra money is being applied towards principal and not applied to intest or future interest. I’ve heard some companies can be a bit tricky unless you specify and even then the processor might get it wrong.
If you really want to go crazy, set up a bi-weekly mortgage payment with your lender and watch the magic happen!
Hmmm…. I’m not sure that interpretting a reduction in the final payment as ROI is correct. I think the correct calculation is how much it reduces you total interest paid over the life of the loan.
It’s absolutely correct. If you spend $100 now and get $158 in benefit 6 years down the road, you got a $58 return on your investment (of $100) over the course of six years.
That, however, doesn’t mean you got a 58% APR. To arrive at your APR, you take your percentage return (58%), divide that number by 100 to get your decimal (0.58), and add one (1.58). Then you take the number of years (6), and take that root of your number(the 6th root of 1.58 is about 1.079), subtract the 1 that you added (to get 0.079), and multiply by 100 (to get 7.9). So 7.9% is your APR.
And if you want to run the math in reverse to check…..
7.9% interest on $100 the first year is $7.90.
7.9% interest on your $107.90 the second year totals $116.40
7.9% interest on your $116.40 the third year totals $125.60
7.9% interest on your $125.60 the fourth year totals $135.50
7.9% interest on your $135.50 the fifth year totals $146.25
7.9% interest on your $146.25 the sixth year totals $157.80
Which, plus or minus a bit of rounding errors, is the $58 in claimed interest. 🙂
So if you could get 1% throwing your money in a savings account, or 3% throwing it in a money market account, you’d be substantial money ahead to throw it at your mortgage – assuming you don’t need that $100 to be liquid any time in that six-year period.
Nicely done Mr. Wall! I didn’t want to get all nerdy in the post so I thank you for your comment.
You are right, I over exaggerated on the rate of return. But you have to admit, turning $100 in to $120 is exciting!