Monday, September 13, 2010

Knock Years Off Your Mortgage and Save Thousands in Interest With This Simple Tip!

One of the proudest moments in our lives is becoming a home owner. To provide your family and loved ones a place to live and grow up is one of life's feelings. A part of realizing that dream is choosing the proper financing, since most of us will not have all the money up front to purchase a home all at once. Therefore, it is important to understand our financing options when approaching a bank or other lending institutions.

In my last article I reviewed a book by David Bach entitled The Automatic Millionaire (http://reynold-savemoney.blogspot.com/2010/09/whats-your-latte-factor-automatic.html). This was a great personal finance book with a lot of solid tips. At the very end of the article I included a short video about how to knock years off your mortgage and save thousands of dollars in interest. The simple trick is to increase the frequency of your mortgage payment. You don't even need to increase the amount that you're paying, just the frequency!

Here's how it works. The bank constantly charges you interest on your loan. The interest is calculated based on the principal that you owe (the total amount you borrowed). With each mortgage payment you make, some money goes towards paying the interest (cost of borrowing) and paying the principal (the original amount loaned). Therefore, with each payment the principal decreases a bit. So the next time around the interest that accrues will be slightly less. This is the magic of compound interest in reverse. By changing your mortgage payment from monthly to biweekly you can save thousands and knock years off your mortgage.

Here's an example to help illustrate the amount of time and money you can save by increasing your mortgage payment frequency:

Mortgage amount: $200,000
Interest Rate: 5% fixed interest rate
Monthly Payment of $1200 or Bi-weekly Payment of $600 (same amount per month)

In this example the mortgage would be paid off 3 years and 13 weeks earlier. The amount of money saved in not paying interest would be $22,800. This could be your hard earned money that would otherwise line the pocket of your banker. Change your mortgage payment frequency as soon as possible!

Pay off your mortgage even quicker with tips from this video:


2 comments:

  1. Payment frequency has no impact on amortization.

    Monthly you pay $14,400 per year.
    Biweekly you pay $15,600 per year.

    The interest savings are due to the payment increase you created when you incorrectly calculated a bi-weekly payment. (You're prepaying the mortgage by $1,200 extra per year)

    If you had properly calculated a bi-weekly payment there would be no savings.

    i.e. $1,200 * 12 / 26 = 553.85 or $14,400 per year.

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