How advantageous are extra mortgage payments
It all depends on how much you spend and when you spend it.
Jul 10, 2015 at 10:21AM
How much time and money can you really save paying a little extra on the mortgage? Well, it depends on how much you spend and when you spend it.
When most people think of loan payments and amortization schedules, they view them as linear. An additional dollar toward the mortgage now is the same as a dollar later. Or the more you pay toward principal every month, the more benefit you receive. Neither of these is true.
The first thing you'll notice is that paying a little more each month saves you money over the long term. With just $30 in additional principal payments a month, which most of us can afford and wouldn't notice, you can save over a year of payments and $13,458 in interest. If you upped it to $300 a month, you save $91,742 over the life of the loan. That's equivalent to a few years' wage for most people.
Now, the most important thing to notice about this chart is that for every additional dollar put toward principal, you get less of a return
than the previous dollar. It's called diminishing returns. That's not what most people would expect, because we're used to getting more when we pay more.
Looking at the $30 and $60 monthly payments, you can see that $60 a month does not give you twice the return of $30 a month. Actually, the first $30 will save you $13,458 in interest, while the second $30 will only give you $12,102. To make matters worse, if you did $500 a month, you would save $124,385, but only $46,235 more if the payment was doubled to $1,000 a month.
The same pattern holds true for the time you save on the loan. The more you pay each month, the less benefit each additional dollar has on time saved.
As Albert Einstein once said, "Compound interest is the eighth wonder of the world. He who understands it, earns it. he who doesn't, pays it."
The effects of when and how much you pay
We're not done yet.
Let's look at when you pay and how much of an impact that has on long term-savings and benefit.
This chart shows the impact of paying an additional $100 a month over different five-year intervals:Source: www.fool.com