Posted by: Bill & Gayle McCord | April 6, 2011

Reducing the Life of Your Loan

Did you know that making 1 extra payment a year drastically reduces the interest you pay AND pays your loan off faster?

By making an extra payment, you reduce interest and pay the loan off faster. For some, it’s best to make an extra payment at the end of the year (Christmas bonus or commission checks, etc.)  For others, this is simply impossible in this economy, so another option is to make bi-weekly payments.  Essentially, you make a half-payment every 2 weeks instead of a full payment once a month.  The result is that you end up making 26 half-payments, or 13 full payments, instead of the normal 12.  The good news is that every dollar of that extra 13th payment goes towards reducing the principal balance of your loan.  That balance  is what future interest calculations are based on. So, as you reduce the principal, you reduce the total interest paid and the length of time it takes to pay the loan.

See below for an example from about.com.

Mortgage Examples

Let’s look at a mortgage with a principal balance of $150,000, a term of 360 months, and an interest rate of 6%.

  • Monthly principal and interest payment = $899.33
  • Total Interest During Life of Loan = $173,757

Using a Bi-Weekly Option

  • Bi-Weekly Payment = $449.67
  • Total Interest During Life of Loan = $135,294
  • The loan is paid off in 24 years instead of 30

Most of us won’t live in a single house for thirty years, but don’t let that stop you from paying bi-weekly, because shorter term savings are significant.

The first figure on each line below shows the loan’s principal balance at the end of that year’s monthly payments. The second figure shows how much principal remains at that same time for someone making bi-weekly payments.

    Year 1
    $148,157 vs. $147,198 (Difference of $959)  

    Year 2
    $146,202 vs. $144,224 (Difference of $1978)Year 3
    $144,126 vs. $141,066 (Difference of $3060)

    Year 4
    $141,922 vs. $137,715 (Difference of $4207)

    Year 5
    $139,581 vs. $134,157 (Difference of $5424)

    Year 6
    $137,097 vs. $130,380 (Difference of $6717)

    Year 7
    $134,459 vs. $126,371 (Savings of $8088 to date)

It’ hard to ignore a savings of $8000 in 7 years.  However, it’s wise to check with your lender to see if (s)he offers a bi-weekly payment plan and if there is a fee involved.

For more information about your real estate needs, don’t hesitate to contact us.

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