Now that the buyer has committed himself or herself to debt for the rest of his or her life (or so the buyer thinks!), it’s time to talk about different payment plans and tax advantages of home ownership.
The largest portion of a monthly mortgage payment goes toward the interest on the loan and NOT principal reduction. If a buyer wishes to save money, he or she needs to compare different payment plans.
For example, if a buyer commits to a 30-year fixed loan of $200,000 at 5% interest, his or her monthly principal and interest payment would be $1073.
• Over the life of the loan, the interest alone paid on $200,000 would be $186,513.
• However, this same loan for 15 years would save a total of $101,828 in interest and only cost $1581 per month in principal and interest!!
Let’s go one step further. Let’s say, you did NOT want the higher monthly payment of a 15-year loan. However, you are willing to make ONE EXTRA PAYMENT PER YEAR of $1073 (This payment is principal and interest, but you’re use to making this payment, so keep it simple and pay this full amount.)
• You would save an additional $35,182 in interest over the life of the loan AND pay off the loan in:
- in 25 years instead of 30 years!
- Also, in the eighth year of the loan (when most people sell), your principal balance would be $155,714 instead of $168,056.
- By making extra principal payments, you also rapidly build equity in your home.
Let’s continue one step further. Let’s say you make TWO extra payments a year of $1073.
- Your loan would be fully paid off in year 21, and the total interest paid on the loan would be reduced to $128,822. By making two extra payments per year, you would save $57,691 in interest!
- And in year 8, your principal balance would be $143,677 instead of $168,056. That’s how to build up equity fast, without even planning on any real estate appreciation.
Now that your head is spinning, let’s view a few more scenarios:
Let’s say that you kept your 30-year mortgage payment of $1073 per month for principal and interest, but you decided to pay an additional $500 per month toward principal reduction. So-o what are the benefits:
- Your loan would be paid off in 15 years.
- You would have paid $85,390 in interest instead of $186,513—over 100K savings in interest!
- At year 8, your principal balance would be $101,591 instead of $168.056.
- And, It is your choice IF you decide to make the extra $500 per month extra payment. When times are good, you may decide to make the payment; When times are bad, you may hold off. However, it’s your choice.
Now that your brain is mentally fried and you need a double Excedrin, stay with me just a little bit longer.
Scenario: You just got a raise and your job security is looking good. You decide to take out a 15-year mortgage on a $200,000 loan at 5% interest:
- Your monthly principal and interest payment is $1581.
- The Total interest paid for the life of the loan is $84,685 (instead of $186,513 on a 30-year loan).
- At the 8-year mark, your principal balance is $100,534.
As you can see, there are various payment plans that you can use to pay off your mortgage early and with less interest. To make extra payments you generally do not need approval, but check with your bank anyway and ask them what the procedure is to make extra payments.
In most states, the buyer can prepay his or her loan without any prepayment penalty. Check with your lender BEFORE you sign the mortgage note. Quite often, buyers use refunds on taxes or bonuses to make extra payments. Also, at the end of the year (or before) verify your balance with the balance of the lender. Always have a paper trail.
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