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Mortgage: MINIMUM PAYMENTS vs Paying Off Early

How much will you actually save by paying off a 30-year in 10, 15 or 20 years?


When Zillow fever strikes, the only cure is to throw down a boatload of cash that you absolutely do not have.


Once that cash is spent, the new furniture is purchased on installment (please do not actually do this - it is a joke), and the first payment comes due, you may actually pause to think about "how on earth am I going to pay this mortgage off"?


Well from a high level, what you are going to do is take the money you earn at your job and hand it over to your banker, with interest, for the next 30 years.


This number, also referred to as the "minimum payment", was made apparent on the loan documentation that you signed to purchase the loan.


A minimum payment is a monthly amount of cash you will have to pay each month or the bank will take the house back. This money goes towards 2 things - principal and interest.


Principal = ownership in the house (a good thing)

Interest = a continuous fee paid to the bank for the loan (a bad thing)


Banks charge higher interest for 30-year loans than they do for 15-year loans.

This is simply because the longer you have to pay them back, the more that can go wrong.


At first, most of the monthly payments goes entirely towards interest. Anything remaining goes towards the principal.


Over time, that small bit that is going towards the principal increases.


This is simple logic.


The more principal you pay off, the more of the house you own (and the bank doesn't own), so the remaining loan amount will decrease, so the interest required on the remaining loan amount will also decrease.


One other way to decrease your interest paid (increase principal) is to pay more than the minimum monthly payments.


For example, my minimum monthly payment is $500. If I pay $600 ($100 over), the extra $100 will go entirely towards the principal.


Doing so will both decrease the amount of time required to repay the loan and decrease the total interest (fees) I pay to the bank.


We are all officially on the same page about how mortgages work.


If you are like most people, you are going to select a 30-year mortgage as it requires a lower monthly minimum payment.


Almost every mortgage loan allows you to pay off your borrowed amount early (some may have early prepayment penalties - check on this before you borrow).


As this is the case, you do have the ability to pay more than the minimum payment to pay off the debt ahead of schedule.


That brings us to the important questions - how much can we save by paying this thing off early and what is the best strategy?


While selecting a 30-year is not technically wrong/bad - personal finance legend Dave Ramsey suggests that you opt for a 15-year loan instead. His basic logic is that most people lack the discipline to do what we are about to discuss (pay off a 30-year more quickly) and that by selecting a 15-year loan that they "force" themselves to be more financially prudent.


If you're up for Ramsey's 15-year plan, you can check out more here. (I'm zero percent affiliated with these guys, just a fan of good work).


Summary


For a $200,00 home, 10% down ($190,000 total loan) with 3% 30-year & 2.75% 15-year.


If you can afford to consistently make $1,300 in monthly payments towards the mortgage, your best bet is to simply choose the 15-year mortgage.


Compared with the minimum payments on a 30-year strategy, you will save $60,000 in fees (interest expense).


If you currently have other debt, I would recommend selecting the 30-year mortgage.

In the short-run, this will likely reduce your overall housing expenses (unless rent is dirt cheap by you), thus allowing you to throw as much cash as possible at your other debt (student loans), and once the other debt is paid off, putting as much toward your mortgage as possible.


With this strategy, you will likely save a bit less on the mortgage ($30,000-$40,000) but more in the aggregate as you attack your higher rate debt.


The worst strategy to follow is simply paying the minimum payment for 30 years and ultimately handing your banker a $100,000 check for fees (interest expenses).


Math & details included below**

Home Purchase Details


$200,000 home

5% down/$10,000 = $190,000 loan

3.00% APR on 30-year loan

2.75% APR on 15-year loan

Pay off a 30-year mortgage in 30 years


At this loan amount/interest rate, you would have a minimum monthly payment of $801.


This DOES NOT include homeowners insurance, HOA fees, and property taxes (as they will continue regardless of how quickly you pay this thing off).


Total interest paid on this loan over 30 years = $98,376.63

Total payments (including interest) = $288,376.63

Total paid = 151% of borrowed amount

Pay off a 30-year mortgage in 20 years


Same facts as before.


The only difference is that we are going to pay an extra $250 each month towards the mortgage.


That brings the total monthly payment to $1,050.


Doing so decreases the repayment date by 10 years and reduces the total interest paid by 36%.


For comparative purposes:


Total interest paid on this loan over 15 years = $63,135.84

Total payments (including interest) = $253,135.84

Total paid = 133% of borrowed amount

Pay off a 30-year mortgage in 15 years


Same facts as before.


The only difference is that we are going to pay an extra $500 each month towards the mortgage.


That brings the total monthly payment to $1,301.


Doing so decreases the repayment date by 15 years (half) and reduces the total interest paid by 53%.


For comparative purposes:


Total interest paid on this loan over 15 years = $46,707.52

Total payments (including interest) = $236,707.52

Total paid = 124% of borrowed amount

Pay off a 30-year mortgage in 10 years


Same facts as before.


The only difference is that we are going to pay an extra $1,000 each month towards the mortgage.


That brings the total monthly payment to $1,801.


Doing so decreases the repayment date by 15 years (half) and reduces the total interest paid by 70%.


For comparative purposes:


Total interest paid on this loan over 10 years = $29,835.92

Total payments (including interest) = $219,835

Total paid = 115% of borrowed amount

BONUS: Pay off a 15-year mortgage in 15 years


Quick adjustments needed:


15-year mortgages typically shave off 0.25% on the rate offered - so the new interest rate on the loan will be 2.75%.


The monthly payment for a 15-year mortgage to be paid off in 15 years comes out to $1.289.


For comparative purposes:


Total interest paid on this loan over 15 years = $42,088.65

Total payments (including interest) = $232,088

Total paid = 122% of borrowed amount



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