Save Money by Prepaying Your Mortgage

Making prepayments on your mortgage can end up saving you a lot of money in interest payments over the life of your loan. What's more, today's low rates on savings accounts mean that paying down your mortgage can offer a significantly better return than stashing the money in the bank.

For most Americans, mortgage payments are already a big part of the household budget. Nonetheless, paying something extra to the bank each month can make lots of sense. How much sense? That depends upon a variety of factors.

How are you going to figure out how much you should prepay and whether it is worth it in the long run? With the help of the Mortgage Payoff calculator from BankingMyway.com, you can easily compare various scenarios to decide whether to prepay your loan and how much money to set aside for that purpose each month.

To use the calculator, just enter the years remaining on your loan, the original term (in years) and value of your loan, the interest rate of your loan and the amount you might want to prepay each month. The worksheet will calculate the total savings in interest over the remaining life of the loan and tell you how long it will take to pay off your loan.

Experiment with different prepayment amounts to see how much sooner you can pay off your mortgage, and how much interest you stand to save under various scenarios. You can also find out how your savings would decrease if you decide to delay your prepayments for a few years. Simply plug in a smaller number for the number of years remaining on your loan.

Earlier prepayments can make a significant difference. For instance, adding $100 to your monthly payment at the very start of a 30-year $200,000 mortgage at 7.0% saves you $63,310 in interest over the lifetime of the loan. If you wait just five years before starting to prepay, you stand to save only $40,201 in interest. In short, you can save an extra $23,109 by making an extra $6,000 in payments over five years.

How can such a small amount make such a big difference? It's because of how the numbers are crunched in a mortgage payment. Only a very small portion of your first payment goes toward paying down the principal of the loan -- the rest goes toward interest. By adding some extra money to pay down the principal right at the start, you reduce the amount of interest payable on the loan (because the principal is dropping faster than scheduled) and so you free up even more of your future payments to further reduce the principal.

But before you start taking apart your budget in order to find an extra $1,200 a year for your mortgage, consider where that money is coming from. A study released last year showed that many Americans were prepaying their mortgages at the expense of sound retirement planning. Missing out on employer-matched retirement contributions led to a loss of tax-related and long-term financial opportunities. The costs of those missed contributions ended up outweighing the interest savings over the life of a mortgage.

Messing with your retirement because you used the money to prepay your mortgage is probably not a smart move. But finding a little extra cash that wasn't already assigned somewhere and putting it toward your mortgage can make a significant difference in your financial prospects.