Owning a home is the American dream. But in order to make that dream come true, many homeowners work with mortgage brokers and take out a loan to pay for most of the purchase. Mortgage loans come at a cost, though. In fact, if you purchase a $200,000 home at only a 4 percent annual percentage rate, you’ll pay more than $143,000 in interest over a 30-year period. You can cut that interest by more than half if you take out only a 15-year loan, but unless you have a huge down payment, your monthly payments will be $5,000 higher and this may or may not include your home insurance policy.
One way to cut down on that interest without a huge monthly bill is to make extra payments as you can. Many experts recommend making one extra payment each year, perhaps by using extra money you get from bonuses or gifts if you’re normally short on cash. But how much of a dent can this extra payment make in that $143,000?
The Mortgage Payment
You’ve found the perfect home, located exactly in the part of town you want to live. The total purchase price is $200,000, so you place a contract on the house. Hopefully you’ve been preapproved, so the seller knows financing won’t be an issue. If the seller accepts your offer, you’ll next line up a closing date and spend the remaining weeks sending requested documents to the mortgage company.
At closing, you’ll be required to make a down payment. If you pay 20 percent down, which would be $40,000, you won’t have to pay private mortgage insurance (PMI). Otherwise, you’ll at least be asked to pay 3 percent down, or $6,000, to secure the loan. That takes the amount you’re borrowing down to $194,000, which reduces your 30-year total interest to $180,916. That $180,916 will be spread over 30 years, with you paying more interest in the earlier months, when the amount you owe on your 30-year loan is at its peak. As you pay more on the principal, which is the $196,000 you borrowed, the interest you’re paying will be based on that lesser amount due.
The Extra Payment
Using a 30 year mortgage loan calculator, you can quickly see how extra payments will reduce the interest you owe. If your monthly payment on your $194,000 loan is $1,041 and you put an extra $1,000 down in the first month, you automatically drop your total loan amount to $193,000. Another $1,000 takes it to $192,000. You’ll pay interest on the new amount, rather than the original $194,000. You can also calculate how extra payments will help you if you take out a shorter loan with a 15-year mortgage calculator.
One important thing to note, though, is that your monthly payment will not drop as a result of this extra payment. Your $1,041 monthly payment will be applied to an increasingly larger part of your principal, with the interest dropping over time. You will, however, start to notice that the total balance due on the bill you receive each month drops lower and lower until, one day, your mortgage is paid in full. The speed at which this happens depends on how much you borrow and how diligent you are with your extra payments.
Since it offers so much flexibility, many homebuyers now opt for the extra payment method instead of taking a 15-year mortgage. They can pay when they have the money without stretching their monthly budget too thin. But it’s important to be disciplined with paying the extra payment, since it can be easy to put things off.