What RM heard was generally correct. But lower interest rates have
changed it a bit. Let's explore mortgage prepayments and how to make them work.
First, recognize that there's a big advantage to getting your mortgage paid off.
It frees up a sizeable amount each month that can be used for other things.
Yes, it's a big long-term goal. But, unlike some other distant goals, you don't
need to get to the finish line to benefit from your efforts. Even if you only
prepay principal one time, it will make every regular payment after that more
RM will want to get familiar with something called an 'amortization
table'. It shows month-by-month how much of each payment goes to paying
interest, how much to reducing principal and what the remaining balance of the
The key factor in paying off any mortgage is how much of the monthly payment
goes to reducing the principal amount owed. For instance, RM would be in
the 18th year of the 6% 30-year mortgage before half of his payment went to
A 30-year mortgage for $150,000 at 6% interest will earn the mortgage company
$173,757 in interest. The monthly payment will be $899.33. But in the first
month only $149.33 of principal will be repaid.
What happens if RM does make an extra payment each year? Fortunately a
mortgage calculator does the math for us. I'm partial to one at
One extra payment per year would reduce the length of the loan to 24 years and 9
months. It also would reduce the amount of interest paid over the life of the
loan to $138,295.
Back to RM's question. Why doesn't the annual prepayment reduce the
30-year mortgage to 22 years? It's because of the low interest rates. If the
rate were 9.2% then one extra payment a year would reduce the term to 22 years.
Same deal for a 15-year mortgage. At a rate of 5.25%, the mortgage would require
a monthly payment of $1,205.82. One extra payment per year would reduce the term
to 13 years and 5 months.
OK, so we agree that prepaying your mortgage is a good thing. But for most
families making an extra mortgage payment doesn't seem like a reasonable goal.
Yet, it isn't impossible. One way to be successful is to break it down into 12
By adding $74.95 ($899.33 divided by 12) to each monthly payment RM would
be doing the same thing as making one extra payment per year. The length of the
mortgage drops to 24 years and 7 months.
A simple change in lunch or entertainment habits could provide that much saving.
Just think of it as trying to avoid spending $2.50 per day. Or, if reducing
spending isn't possible, perhaps RM could use his next salary increase
for mortgage prepayment.
Refinancing your current mortgage could also be a solution. Instead of using the
extra money for other things, continue making the same monthly payment that you
made before the refinancing.
Suppose that RM had a $150,000 8% mortgage and refinanced to 6%. The
difference in payments is $201.32. But if RM continued to pay the $1,100
that they had been paying before the refinancing, he'd have the mortgage paid
off in 19 years and two months.
Before you make any prepayments you need to check your mortgage for two things.
First, verify that prepayments are allowed. Second, make sure that any extra
amounts that you send in are applied to reducing principal. In fact, you'll
probably need to indicate on your check or the payment stub how much extra is
meant for principal reduction.
It's a good idea to make sure that the bank is applying any prepayments
correctly. More than one person has had a prepayment applied as an 'early
payment' for the next payment due. That will not do you any good.
There are services that charge to check your balance. But it's really not that
difficult if you have a copy of the amortization table. Based on the previous
month's principal owed, the table will tell you how much of your regular payment
would go to reducing the principal. With that and the amount of your prepayment,
you'll be able to calculate the new balance. Just verify that amount with the
mortgage company by phone or the web.