House Hunters or Jersey Shore?
Some questions can be answered with relative ease by almost everyone.
When it comes to paying down mortgages early, however, a much more perplexing question for most folks is whether it’s better to make a single large extra principal payment annually or twelve smaller ones each month.
Is one method better than another?
Does one prepayment method save more interest and result in a quicker loan payoff date than the other?
Let’s assume we have a 30-year loan for $200,000 at an interest rate of 6%. After crunching the numbers (and rounding them just a bit for clarity) we get the following results:
It would take 297 months (24.75 years) to retire your loan if you make one extra payment of $1200 annually. On the other hand, choosing to make 12 additional monthly principal payments of $100 each year would allow the loan to be paid off two months sooner, saving an additional $1830 interest in the process.
Then again, over a 24-year period, that’s almost a wash considering the amount of interest paid overall, not to mention inflation’s insidious impact on the dollar’s purchasing power over time.
Now, I know what you’re thinking: But Len, is the impact any different for a shorter loan?
Again, let’s assume we have the same loan amount and interest rate as in our first example, however this time we have a 15-year mortgage. Here are the results:
As you can see, no matter which path you choose, it’s essentially the same answer once again, although the difference between the two methods is even less pronounced with the shorter loan. In this case, making 12 equal extra payments of $140.66 every month would retire the loan in 160 months (13.33 years) — that’s one month sooner than making single annual payments of $1688.
So there you have it. When it comes to making extra mortgage principal payments, there is very little difference between the two methods, regardless of whether or not you have a 30-year or 15-year mortgage.
Now if you’ll excuse me, I have to go downstairs; the Honeybee wants me to order us a pizza for dinner.
The trouble is I’m not sure if I should make it sausage or pepperoni.
Photo Credit: Woodley Wonderworks