After playing with the numbers a bit, we decided that it might be a good idea to start pre-paying the mortgage on our new house. And what better time to do so than with our very first payment? We ultimately decided to overpay each month by roughly 1/12 of our payment — our current monthly payment (including taxes and insurance) is $1412.98, so I decided that $120 was a nice, round number for our extra payment — that equates to a little better than one extra payment each year.
Since the first payment went to the lender that originated our loan just before they sold the mortgage servicing rights, I logged in yesterday to make sure that the additional funds found their way to Wells Fargo Home Mortgage. But when I logged in, I learned that I had made a $174.58 overpayment, not a $120 overpayment. I double-checked our checkbook register as well as the math, and they were right — for some bizarre reason I had written the check for $1587.56 and, for the life of me, I can’t figure out why. It’s not like I was rounding off to some nice even number — rather, I had written the check for a seemingly random amount. Weird. Oh well, I guess there’ll be an extra $54.58 working for us over the life of our mortgage.
Overpaying over the life of the loan can shave several years off the life of the loan, it is a very good idea. I intend to do the same with my car loan, at least as long as I have the car. If I decide to sell it to get rid of the loan and be debt free faster then that will be much better, as long as I am not upside down in the loan at the time I sell and I can afford to get another car (that I can actually afford) to replace it. Either way, I have a mutual fund thAt I will put most of thse monthly payments in, for a future car down the line (10-15 years) that I will pay cash for with that saved money. Eventually I will be able stop putting money in that fund because I will have enough cash saved to buy 2 or 3 cars, keeping them each at least 10 years. Anotherwards, lets say I only fund this fund for 10 years. Considering my payments alone, after 10 years of saving those payments I would have enough to buy 2.5 cars or put another way I would have enough to buy a good used car once every 10 years for 25 years. By which time I will be in my 60’s with not much need to buy another car after that.
That’s what we are doing as well, Nickel, except that I did not figure it out to be 1/12 of an extra payment…it just worked out that way. Fancy that!
Once we are sure that the student loans and financial aid for law school have funded though I am going to be putting an extra 1/2 payment in; I want to keep the cash around just in case for right now though. Hopefully our August payment.
For encouragement, fire up a spreadsheet to calculate how much you’ll save in interest. Even a small monthly overpayment easily turns into thousands of dollars in savings.
As for “put it in a mutual fund, it pays better,” that may be true on paper, but remember your rate of return on a mortgage prepayment equals your interest rate. 8% is a pretty good rate of return–and it guaranteed and is absolutely RISK FREE.
Oh, and watching where the money goes is always important. I once had a lenders credit an overpayment against future regular payments rather than against principal. A phone call straightens it out, but don’t assume they know what you are trying to do.
It is comforting watching the mortgage balance drop. But I recently came across this article that offers another alternative for long-term savings. For many people it is more effective to direct the money into tax deferred retirement accounts — especially in the US where you can deduct mortgage interest expense. We’re currently living in Australia where mortgage interest is not tax-deductible. Even so, recent newspaper articles here are promoting the idea of contributing to tax-deferred accounts rather than pre-paying the mortgage.
Of course, this is more attractive the closer you are to retirement. Many 20-30 year-olds will prefer the flexibility of pre-paying the mortgage and being able to re-draw or get a second mortgage should funds become tight.
Pre-payments are great — but your individual situation has to be considered. If housing values are dropping (in real, inflation adjusted terms) in your area, pre-payments might save you interest expense, but the equity that you are supposedly building is just disappearing. Better to let the bank assume the risk, and keep your money somewhere that will keep it earning above the rate of inflation.
When I made prepayments on my mortgage I sent 2 checks- one for the regular monthly payment and another one specifically designated as a prepayment on principle. Thit helps eliminate confusion on their part as to what to do with the extra check. I then followed up with a current printout of my amortization schedule to make sure the extra amount was applied to principle.
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