Enough background, lets get to saving money NOW!

The way to start saving money in interest ANYTIME is called making a prepayment. Here is an example of this simple way to save money. Lets say you purchased your house (or for that matter refinanced) and you took out a $250,000 fixed rate mortgage at 6% for 30 years. Your monthly payment (principal and interest) would then be $1,498.88. Do you realize that over the life of the loan, with principal and interest you will have paid back nearly $540,000? Can you believe that’s over $290,000 IN INTEREST ALONE on a $250,000 mortgage? Here is how to save thousands on those interest charges.

Please note: For your convenience, will be using the $250,000, 30 year, 6% mortgage and the monthly payment of $1,498.88 example to show various ways of saving money on your mortgage throughout this site.

When you make your $1,498.88 monthly payment, lets make what is known as an ADVANCE PAYMENT or a PREPAYMENT of principal of $100 on your principal for a total monthly payment of $1,598.88. By adding $100 to the $1,498.88 base payment each and every month, you will save over $51,500 in interest over the life of the loan. $51,500!! In addition you would have paid off your mortgage much sooner. Your mortgage would now be paid off in 25 ½ years instead of 30! Think about it, by making a small prepayment of $100 (about $3 a day) you would save over $51,000 in interest charges and own your home free and clear 4 ½ years sooner. And if you could afford to make a prepayment of $200 a month, you would save over $86,200 in interest and you would own your home free and clear in 22 years and 3 months. Here is how you can get these savings.

Each month when you make your mortgage payment, a portion of that payment goes towards paying the INTEREST on the outstanding balance of the loan first. The remainder of that payment then goes towards REDUCING the outstanding loan balance. Each month, then, the amount that is applied to interest will go down because of the lower outstanding balance, and a larger amount will be applied towards principal reduction.

How Prepaying your Mortgage Saves You Money

A prepayment is exactly what it says. When you make a prepayment, you are making a principal payment AHEAD of schedule. This is not an “extra” payment but rather a payment in advance towards your principal balance. By making a prepayment you lower your outstanding principal balance quickly, thereby reducing the amount you pay in interest over the life of the loan. It’s compound interest in reverse!

The easiest way of seeing the monthly breakdown of your loan is by using an AMORTIZATION SCHEDULE. What is an amortization schedule? An Amortization schedule is a statement that shows the monthly allocation of principal and interest and also shows the remaining balance of your loan. Below is a partial amortization schedule utilizing our mortgage example.

In the previous example, you see that each month as the loan balance goes down, the interest charge also goes down, but very slowly. Using the previous example you see that most of your monthly payment goes towards the interest until payment number 223. READ THAT AGAIN—after making 223 payments (18 years, 7 months worth of payments) you start to pay more towards principal than interest! Obviously then, the faster you pay the loan balance down, the less interest you pay.

Here is one simple way of saving money on those interest charges: when you make a prepayment on principal, you will save that months interest. Look at the amortization schedule again. When we make our first payment of $1,498.88 in January, add to that the principal portion of the February payment, which is $250.12, for a total first’s month payment of $1,749.00. By doing this, you have accomplished several things. First, you have gone from payment number 1 all the way down to payment number 3 and thus you will eliminate the $1,248.76 interest charge for February. You have just saved nearly $1,250 (over the life of the loan) by making a small $250.12 prepayment! In addition, you have shortened the length of the loan by one month. Instead of your mortgage being paid off in 359 payments from now; it will be paid off in 358 payments.

Lets continue: when we make our second payment in February, we make our $1,498.88 payment plus April’s principal payment of $252.63 for a total payment that month of $1,751.51. By doing this we will save $1,246.25 in interest that month. We have now made 2 prepayments, and will save $2,495.01 ($1,248.76 + $1,246.25= $2,495.01) in interest over the term of the loan and shorten the length of the loan by 2 months.

Now when we make our third payment in March, we pay the $1,498.88 plus June’s principal payment of $255.16 for a total payment that month of $1,754.04, and we save $1.243.72 in interest that month.

Let’s summarize; what we have done here is by making three monthly payments (January, February and March), prepaying the next month’s principal (as we have done three times) we will cut thee length of the mortgage by 3 months, and will save $3,738.73 in interest charges over the life of the mortgage. Once again, by making three small prepayments you will save nearly $3,800. By continually doing this—adding the next month’s principal payment to the base payment (in this case $1,498.88), you will cut the loan term from 30 years to 15 years and save over $160,000 in interest in the process! All this is accomplished by letting your amortization schedule act as your guide.

Instead of adding an odd dollar amount each month, you may prefer to make what we call the Equal Dollar Amount Prepayment. This is a prepayment  which will be the same amount each month. Why the same amount each month? Some people prefer to make a prepayment of the same amount each month because it’s easier to budget when you write that monthly check. Many of our readers have started prepaying this way after they have recently paid off a monthly credit card bill or after finish paying off a car loan. They then started to apply their former payments towards their mortgage. Next is and example of an Equal Dollar Amount Prepayment prepaying $100 a month starting at the beginning of the loan.

Summary

Total interest if not prepaid $289,593.09

Total interest if prepaid $238,021.70

Total amount saved prepaying $ 51,571.39

Number of months saved prepaying 54

As you can see, you will save over $51,500 in interest and cut 4 years 6 months off the length of your mortgage.

Are you facing retirement in a few years? Do you really want to be paying a mortgage when you retire? Here’s a plan that will allow you to be mortgage free when you retire. Let’s say you have recently obtained a mortgage and you plan to retire in 12 years. Let’s use our earlier example, but change the dates for simplicity. You started your mortgage in January of 2007. Its now November of 2009 and you want to have the mortgage paid off by November 2021, the month you plan on retiring. Using our earlier example, you see our mortgage balance at the end of October 2009 is $240,801.25. In order for the mortgage to be paid off by November of 2021, you will have to add a prepayment of $850.00 a month. The new monthly total will be $2,348.88 ($1,498.88 + $850.00)

Summary

Total interest if not prepaid $289,593.09

Total interest if prepaid $139,407.49

Total amount saved prepaying $150,187.98

Number of months saved prepaying 181

Next, you will need to obtain an amortization schedule. If you do a search on the web you should be able to find one easily. An amortization schedule is very important so you can track your payments, plus to make sure that the banks credit your account properly. Which leads to…The Correct Way to Send In Your Prepayment.

After your first prepayment you may want to call your lender to verify that they credited your prepayment to the outstanding balance. When I started to prepay my mortgage, I waited 6 months until I checked my balance. MISTAKE!! I called to verify my mortgage balance, and their amount was VERY different from mine. The bank was not applying my additional payments to my mortgage balance; they were applying it to my escrow account. I then printed out my amortization schedule and sent it to them to show the correct balance. They quickly corrected their mistake. Lets face it, we balance our checkbook each month, why not use an amortization schedule to check you mortgage balance.

It seems many people get hung up over the deductions issue. If the deduction is so important, why do people refinance for a lower rate? They would get a bigger deduction with a 10% mortgage instead of a 5%, don’t you agree? It makes more sense to me to have NO mortgage and spend nothing than to have to spend money on a 5% but get something back.

Let’s see how prepaying $200 a month on our $250,000 mortgage will affect your taxes. By not prepaying you would have a first year interest deduction of  $17,415.24. When you prepay $200 a month, your interest deduction that year would be $14,849.36, a difference of $2,565.88. By making the prepayment you will end up saving over $11,314.52 in interest over the life of the loan. You will also cut 9 months off of the mortgage too.

PLAN 5: PAYING YOUR 30-YEAR MORTGAGE AS A 15 YEAR MORTGAGE

EXAMPLE: Adding $610.76 to each payment to pay off a 30-year mortgage in 15 years.

Summary

TOTAL INTEREST IF NOT PREPAID $ 289,593.09

TOTAL INTEREST IF PREPAID $ 129,735.83

TOTAL AMOUNT SAVED PREPAYING $ 159,857.26

NUMBER OF MONTHS SAVED BY PREPAYING 180

So when you feel comfortable with a higher payment (the prepayment) start prepaying and enjoy the savings!