Do you have a 15- or 30-year loan that you’d like to pay down faster? You might find that making extra payments on your mortgage can help you repay your loan more quickly, with less interest.
What is loan amortization?
Amortization means paying down a loan’s balance over time with periodic payments. For example, if you make a monthly mortgage payment, a portion of that payment covers interest and a portion pays down your principal.
Typically, the majority of each payment at the beginning of the term pays for interest. Assuming regular payments, more of each following payment pays down your principal. This reduction of debt over time is amortization.
How can making extra payments help?
When you make an extra payment, that money is applied to the principal. Because interest is calculated against the principal balance, paying down the principal in less time reduces the interest you’ll pay. Even small additional payments can help.
Let’s say you have a 30-year fixed-rate loan for $200,000, with an interest rate of 4%. If you make your regular payments, your monthly mortgage payment will be $955 for the life of the loan, for a total of $343,739 (of which $143,739 is interest). If you pay $100 extra each month, you can cut your loan term by more than 4.5 years and save more than $26,500 on interest. If you pay $200 extra a month, you can cut your loan term by more than 8 years and save more than $44,000 on interest.
Another way to pay down your loan in less time is to make half-monthly payments every 2 weeks, instead of 1 full monthly payment. When you split your payments like this, you’re making the equivalent of 1 extra monthly payment a year (26 bi-weekly payments totals 13 monthly payments). This extra payment is applied directly to your principal balance.
Using the same example as above, if you make a payment of $477.50 every 2 weeks, instead of 1 monthly payment of $955, you could shorten your total loan term by more than 4 years and save more than $22,000 on interest.
A little goes a long way
Making your normal monthly payments will pay down, or amortize, your loan. However, if it fits within your budget, paying extra toward your principal can be a great way to lessen the time it takes to repay your loan and the amount of interest you’ll pay.
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