When a little extra is included with a loan payment, that extra amount goes to reduce the amount owed. This extra amount can have quite an impact early in a loan's life.
- I had a neighbor ask me if it was a good idea that she start including a little extra in her monthly mortgage payment. She had been told that that little extra could make a big difference in the end. What do you think? - Well, paying down debt early is almost always a good idea, so yes. If your neighbor has a little extra cash each month, then it is a good idea to apply the amount to reduce the mortgage. - Will that little extra make that big a difference? Let's look at a couple of examples. Suppose you just took out a $200,000 30 year mortgage with a 3.6% interest rate.
Your monthly payment each month for the next 30 years would be $909.29. - That means that, in 360 months, your mortgage balance would be zero and you'll own your home free and clear. But let's suppose that in addition to the $909.29 each month, you round your payment up to an even 1,000. In other words, you start making $1,000 payments. What difference do you think that will make? - Well, if we run the numbers, it turns out that you will cut out about 55 payments off the end of your loan.
That is over 4 1/2 years just by adding an additional $90.71 to your loan payment each month. - But let's suppose I'm well into paying for my house. Let's suppose I'm just starting my 20th year of payments. Will it still make a big difference then? - Well, again, if we run the numbers, we'll find that we reduce the number of payments we will make, but only by about 14 months in this case. - Why so short? Because the sooner you can pay the extra amounts, the sooner you buy down your loan balance, the less interest you have to pay, and the sooner you can pay off your loan.
- Now, let's suppose that the budget is just too tight to pay the extra amount each month. Any other option? - Absolutely. Let's say you receive an annual bonus from work. Take some of that bonus and make a one time payment each year to reduce the principle on your loan. - Now let's assume that with each 12th payment, you include an extra $1,000 as part of your final payment for the year. You are using that Christmas bonus to give yourself and your family a little financial security. - So if you pay an extra $1,000 each year with your last payment of the year, you will have reduced the number of payments you'll be making by about 50, just by making, in effect, an extra one payment each year.
- Now let's suppose I get some sort of windfall, an inheritance, lottery winnings, or something like that. Let's suppose I have an extra $30,000 of cash. What happens if I just apply that to my mortgage? - Well, the answer to that depends on when in the life of your mortgage that windfall appears. Let's suppose at the start of your second year of the payments you can pay an additional $30,000 with your 13th payment. You will reduce the number of total payments you will make on your loan by 83. That's almost seven years of payments vanished.
- But if this windfall comes to you at the start of your 20th year of payments and you apply an extra $30,000 to pay down the principle of your loan, you'll only reduce your loan length by about four years. - The lesson: the more you can pay and the earlier you can pay it, you can significantly reduce the life of your loan. - When it comes to savings, the more you can save and the earlier you can save, the bigger the difference it can make in your overall savings amount. The same holds true in the opposite direction for debt.
- The more you pay and the earlier you pay it, the bigger the difference it can make in reducing your debt. At the front end of a loan, a little extra can make a big difference.
Skill Level Beginner
Q: Why can't I earn a Certificate of Completion for this course?
A: We publish a new tutorial or tutorials for this course on a regular basis. We are unable to offer a Certificate of Completion because it is an ever-evolving course that is not designed to be completed. Check back often for new movies.