“Death Pledge”. No this is not a scene from “The God-Father” but that really is what the term “mortgage” means. However, I like to apply that term to all debt. Most people back in the day worked until they died and still may not have paid the loan off hence the name “Death Pledge”. With a name like that and from the looks of the guy in the pic above, a mortgage or any large debt is something I don’t want to have anymore. And if I had to get it, let it be as small as possible and more importantly get that *&$** off my back ASAP!!!
In the final post of this series I will show you using my mortgage figures how beneficial it is to you to pay off “The Death Pledge” as soon as you can. This info can be applied to any large loan. Yeah I know, the financial experts tell you to invest that money in the stock market or whatever is the hottest investment going around. And that the market historically returns X %. But what they don’t like to tell you is that paying off your debt is a guaranteed return on your money and the less debt you’re carrying like the guy in the pic above, the better off you are in case of an unexpected change in your financial status like a job loss.
WARNING: This post has boring figures in it and is a tad long but it will save you big money in the future!!!
If you are in the position and desire to pay off the mortgage, make sure whatever extra you are sending is clearly marked “For Principal Only” in the memo section if you are paying by check. It’s even better if you write out a separate check from your regular payment. If you are paying online, look for the section marked “Additional Principal” or something like that and input the extra amount you are paying. Also check the balance with the bank after you’ve made each and every extra payment.
Why am I telling you this? If you don’t do this the bank is not going to automatically assume that you want to pay down your debt at a faster rate and will apply that extra towards future payments. Now you may think well that’s ok, it’s paying down the debt. In a way you are correct. However, the amount of interest especially on a mortgage or any loan for that matter, is on the front end of the loan. This is why you have been making payments for 20 years and still owe just as much as the original price of the house even though it’s 20 years later. What you’ve been paying all that time is mostly interest and very little towards the principal. This is magnified on a 30 or more year loan. Take a look at your amortization table and you’ll see what I mean. If you don’t have one there are calculators with amortization tables on the Internet. I believe at one time the mortgage company was required to give these out but in recent years if you wanted one you have to ask for it. I think too, since they don’t have to do it anymore, some mortgage holders charge for the table. Once you take a look at yours for your loan, you’ll see why they don’t want to provide you with one. The faster you pay down the principal the less money they make in interest.
On a mortgage, the interest is calculated on the remaining principal balance. The larger the balance, the larger the interest portion of the payment is. That’s less money going toward paying down the principal. Remember, principal is just a short cut word for the original amount borrowed or original sales price. Here’s an example from the amortization table on my retired mortgage.
- On the $48,175 beginning balance on the loan the 1st payment due on August 1st, of $413.06. $250.91 of that payment is going towards interest, the remaining $162.15 goes toward paying down the principal. Principal balance now is $48,012.85.
- The interest charged on the next payment is figured on the balance of $48,012.85. Now if you make extra payments and for the sake of ease, that total payment is $1,239.18 ($413.06 x 3) but you don’t specify the extra $826.12 is for “principal only”, what they are going to do is apply that amount to your next two payments after the current payment and tell you your due date is November 1st. What this means is you will have paid $499.29 ($250.07 & $249.22 respectively) in interest and only $326.83 ($162.99 & 163.84) pay down of principal. Principal balance $47,686.02. Notice how little the pay down of the principal decreased but you’ve made a $1,239.18 payment.
- By specifying “for principal only” application of that $826.12 extra payment, the new principal balance that interest is calculated on is $47,185.73. That does not seem like a lot from $47,686.02, a difference of $500.29. But here’s the kicker. $988.27 is applied to principal pay down and only the $250.91 is paid in interest.
- By not doing this the bank makes $661.44 off of you on this one transaction. Multiply that over the life of the loan and it becomes apparent how profitable it is for folks to remain in debt and not apply extra payments properly.
I had a 15 yr mortgage. On a 30 year mortgage, the pay down of principal is at a slower rate thereby more interest is paid out. The interest paid will be higher the larger the loan.
The fantastic thing about this, on a fixed rate 30 yr mortgage, by paying $25-$50 extra each month, the payoff can be reduced by as much as 5 years. One extra mortgage payment either as 1 payment or divided up throughout the year can reduce the payoff down to 18 years. This saves tremendous amounts of interest.
Please don’t pay for anyone to set you up on a “bi-weekly payment plan” or any of that other mess. There is almost always a fee involved, many times a setup fee plus a monthly fee and you are locked into those terms. Take that fee and apply it to your principal yourself. And if for some reason you don’t have the extra you are still in compliance with the terms of the loan by making your regular payment.
Think about the day when you don’t have to make that payment anymore.
I hope this helps.