Are you thinking about making 1 extra mortgage payment a year? Did you hear that it cuts a bazillion years off the term of your mortgage? Is that actually true…? And should you start making these extra payments?
These are great questions! And there’s actually another good one that you may be asking — “What if I’m already halfway into my mortgage payments? Is it still worth it for me make these extra payments?”
Yup, we’ll answer this too. Let’s hit it!
Benefit of Making 1 Extra Mortgage Payment Per Year
If you make 1 extra mortgage payment a year, you WILL save money on your overall mortgage, and you WILL pay it off sooner. All that is true.
But the big question is, ‘What is the real impact? Is it really worth the added effort and dollars?’
Let’s say you currently have…
- A $300,000 mortgage
- an interest rate of 3.2%
- a fixed-rate 30 year mortgage
If you start making 1 extra mortgage payment a year from the very beginning of a 30-year fixed mortgage, you will:
- only have to pay your mortgage for 26 years
- and you’ll save $22,000 in payments!
(And FYI, if you’d rather make bi-weekly payments, that’s effectively the same thing because you’re making 1 full extra payment by the end of the year).
By making just one extra payment a year on your mortgage, you’ll be able to pay off your house four years earlier. That’s fairly substantial! But why is that?
How is it that just one extra payment a year can save you 4 years and $22,000 in interest?
The answer isn’t as complex as you might think.
Let’s say you owe $300,000 on your house and your interest rate is 3% per year. In that first year, you’re going to pay $9,600 in interest (ie. $300,000 x 3.2%). If, however, you made the principle payment early (ie. the non-interest part of the payment), then you don’t owe the interest on that payment!
So, when you make one extra payment a year, you’re essentially cutting out the interest of one payment per year.
With our example above, the full year interest is $9,600 over the course of 12 months. So, by cutting out one payment, you’re essentially cutting out 1/12th of that $9,600 interest payment, or $800. Do that for 26 years and you’ll have four year’s worth of interest already paid for and you’ll therefore be done paying your mortgage four years early!
Do you have a higher interest rate than 3.2%? Your extra mortgage payment each year will have a greater impact.
Have a lower interest rate than 3.2%? Then your extra payment per year will have a lesser impact. If you can do it though, there’s still a definite benefit!
The Impact of 1 Extra Mortgage Payment on a 15-Year Loan
Okay, so you can save 4 years’ worth of payments on a 30 year mortgage, but you may now be asking yourself, “What if I make 1 extra mortgage payment a year on a 15-year loan? Is it really worth it then? How much money will I save? And how many years will it cut off of the 15 year term?
Let’s stick with the same assumptions: a $300,000 loan and a 3.2% interest rate, but now a 15 year term.
If you make 1 extra mortgage payment a year on the 15 year fixed loan, you will save:
- $8,000 in interest payments
- and 1.5 years worth of payments (ie. you’ll pay off your home in just 13.5 years instead of the assumed 15)
As you may have guessed, the impact isn’t that spectacular, but hey, you do still get to become mortgage free in just 13.5 years, so that’s something!
“Derek, what if I’m already 10 years into my 30 year mortgage? Then what’s the impact of me making an extra payment a year? Is it still worth doing?”
If you’re 10 years into a 30 year mortgage, you likely now owe just $240,000 or so on your mortgage, which means that the interest is no longer $9,600 a year. Instead, it’s $240,000 * 3.2%, or $7,680 a year. So, your extra payment is only about 85% as effective as year one. But, still effective obviously!
As you work your way through the years of your loan term, your monthly payment will be made up of less and less interest and more and more principle, which means that there’s fewer and fewer dollars of interest to save.
Mid-Mortgage Term Saving Swags
So, just my swag here, but if you’re 10 years into a 30 year term, instead of saving 4 years off your mortgage term, you’re probably only likely to save 2.5 years (and roughly $13,000).
If you’re 20 years into a 30 year term, you can probably only impact your mortgage term by about 1.5 years (and roughly $8,000).
Again, it’s always worth it just to get started and save as much money as you can, but it’s also always more effective to start sooner rather than later!
How About the Lump-sum Payment Route?
Personally, I’m not a big fan of making 1 extra mortgage payment a year. I think it’s an easy feel-good thing to do, but it’s hardly ever the MOST you can do. It’s the same reason I don’t promote Digit. Sure, it’s great to have a robot automatically put money into a savings account for you…but is $15 a month into a savings account really going to be all that impactful? Nope.
And will making one extra $1,300 payment every year really change your life? Nope.
Instead, I’d rather people get intentional, make a plan, and then BUST IT! Both with their savings and with paying off their mortgage.
“What happens if I make a lump-sum payment on my mortgage?”
In other words, what if, instead of making one extra $1,300 payment a year, you instead save up $10,000 and plunk it on the mortgage? What kind of impact does that have?
Yeaaahhhh, NOW WE’RE TALKING! Now I bet we’re making some big changes to our mortgage balance!
With that $10,000, you’re essentially covering the principle on 20 mortgage payments, which means in that one big payment, you’re wiping out about $15,000 worth of interest! BOOM!!!
How is this possible?
With a $300,000 mortgage, the payment is roughly $1,300 a month — $500 goes to the mortgage principle, and $800 goes toward the interest. When you make your big $10,000 payment toward the principle (FYI, be sure they always apply your extra payments to the principle), you’re paying 20 payments of that $500 principle, which means you never have to pay the $800 in interest on those 20 payments. And this means you save roughly $800 twenty times over!
Make 1 Extra House Payment a Year? Nope. Do More.
So should you make 1 extra house payment a year? If that’s all you can do, then sure. Do that.
But my guess is, you can do more.
Make an effort to first put 15% away toward some form of investment each month, and then stash as much money as you can toward that mortgage payment.
- If you can afford to throw an extra $2,000 a month toward the mortgage, do it
- Work a little extra and put $3,000 a month toward the mortgage? Even better.
- Can you do more? Then do it! Get rid of that mortgage and then invest aggressively. You’ll never regret it.
Don’t make one extra house payment a year. Instead, make an extra house payment every month.
You’ll slay your mortgage faster than you think, and then you’ll be sitting completely debt free in just a few years. Worth it? Absolutely yes.
Related: How to Pay Off The Mortgage Faster
My name is Derek, and I have my Bachelors Degree in Finance from Grand Valley State University. After graduation, I was not able to find a job that fully utilized my degree, but I still had a passion for Finance! So, I decided to focus my passion in the stock market. I studied Cash Flows, Balance Sheets, and Income Statements, put some money into the market and saw a good return on my investment. As satisfying as this was, I still felt that something was missing. I have a passion for Finance, but I also have a passion for people. If you have a willingness to learn, I will continue to teach.