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<< Previous   of   Next >>   ADVERTISEMENT   CONTACT THE HERALD Mike Benbow, Business Editor benbow@heraldnet.com   Published: Sunday, February 3, 2008 Paying extra on principal is worth it By Steve Tytler Question: Will you please write about how to help pay off real estate loans quickly to save money. A banker can make out a loan amortization schedule for you. On the schedule you can write the check number next to the month paid, and if you add the principal amount for the following month, you can skip that month's payment and save all of the interest expense. I am 81 years old and I have been doing this on all of our loans for years and saved a lot of money. I just wanted to pass this tip on to help others. A.Y., Brier Answer: For many homeowners, the idea of owning their home "free and clear" of any mortgage debt is the ultimate "American Dream." There are many ways to pay off a loan early. You can pay a fixed additional principal payment each month along with your regular mortgage payment. For example you might want to pay an extra $100 toward the principal each month. You can also make an extra mortgage payment each year, or simply make a large lump sum payment toward the principal balance each year. The possibilities are endless. The principal payment method you described allows homeowners to cut their loan term in half by "accelerated amortization." The savings are enormous, especially during the first few years of a 30-year mortgage when the lion's share of each monthly payment goes to pay interest expense. For example, a $250,000 loan with a 30-year amortization schedule and a fixed interest rate of 6.0 percent would have monthly payments of $1,498.88. With payment No. 1, $1,250.00 of that amount is interest, with only $248.88 applied to paying down your principal. Five years into the loan, with payment No. 60, the portion of the monthly payment applied to reducing the loan balance has grown to only $335.70, with the remaining $1,163.18 going to interest. By using the reader's payment method of "skipping ahead" on the amortization schedule, you would save an average of about $1,200 worth of interest for each extra principal payment made. The following amortization schedule shows the first four monthly payments of a 30-year fixed $250,000 loan at 6.0 percent interest with total monthly payments of $1,498.88 Principal Interest No. 1 $248.88 $1,250.00 No. 2 $250.12 $1,248.76 No. 3 $251.37 $1,247.51 No. 4 $252.63 $1,246.25 Here's how the accelerated amortization program works: On your first loan payment, you would pay the regular payment amount of $1,498.88, plus the $250.12 in principal you would have paid on payment No. 2. In other words, you would send in a total of $1,749.00 the first month, and by doing so, you bypass the $1,248.76 worth of interest you would have paid on payment number 2. The next month, you move down the amortization schedule to payment No. 3. You would pay the regular payment of $1,498.88 plus the $252.63 principal amount scheduled for payment No. 4, for a total payment of $1,751.51. Again, you would effectively save the $1,246.25 in interest that would have been paid on payment No. 4. You keep doing this, skipping down the amortization schedule and writing in the date and check number of each payment as you go. By the end of the 15th year, your "30-year" loan is totally paid off and you will have saved more than $140,000 in interest expense. Notice that the extra principal amount paid each month is relatively small but the long-term savings are enormous. Month by month, year by year, your mortgage payment gradually grows bigger and bigger -- but at the same time, your income would probably be increasing and inflation would be eating away at the value of the dollar. It is a relatively painless way to quickly pay off the debt against your home. Now, many of you are probably thinking, "That's WAY too complicated for me!" Don't let that stop you from reaping the benefits of making additional principal payments on your mortgage. You don't have to carry it out to the extreme of following the amortization schedule. You can simply pay an extra $100, $200 or whatever amount you can afford each month and accomplish the same goal. For example, if you added an extra $300 each month to the regular $1,498.88 monthly payment on a 30-year $250,000 loan at 6.0 percent interest, you would reduce the loan term to 20 years and save more than $111,000 in interest expense. If you paid an extra $500 each month, you would pay off the loan in about 16 and a half years. It's like paying off a credit card bill. If you send in only the minimum required payment each month, it takes forever to pay off the balance. But if you pay double or triple the minimum payment due, the card is paid off in no time. Any way you look at it, paying an extra amount toward the principal on your home mortgage will save you big bucks over the long run. The tough part is having the financial discipline to stick with the program. It's hard to put off spending fun money today in order to cash in on a reward 15, 20 or 25 years down the road. And remember, you only get the full interest savings benefit of making additional principal payments on your mortgage if you hold the home for the full original term of the loan. If you pay off your mortgage early by selling the home after 5 years, you will still save some money on the interest expense, but it will be a relatively small amount. Mail questions to Steve Tytler, The Herald, P.O. Box 930, Everett, WA 98206, or e-mail him at economy@heraldnet.com.

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