Have you ever wondered how mortgage interest rates work ? How they could impact your pay off strategy ? How to outsmart the banks by slashing your total interest payments by half ?
Here is the sad truth about a mortgage rates. Though they allow you to build equity and escape from renting ever increasing rent prices ,if you follow the traditional 30 year payment, you will almost always pay double the price by the time you finish paying it off.
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Here is what I mean.
If you take a $500,000 mortgage loan for 30 years at 5.25% interest rate you will pay $493,000 in interest and the full $500,000 payment of the principal. For a total of $993,000.
How much does a 2% Mortgage interest rate difference really matter ?
As I am writing this, mortgage rates are 7.25%. What does this exactly mean ? The same house loan of $500,000 with a 30 year loan will cost you $727,000 in interest alone. Making the total for the house $1,227,917 MILLION !!!
How can you avoid paying double the price of your house ?
I am not going to lie to you and say you can pay zero interest for your house. That is not possible, unless you buy your house with cash. The good news is you can reduce your total interest payment.
Here is how:
Lower your loan payment term/year
Go for shorter number of years. Opt for a 15 year mortgage loan instead of a 30. Your monthly payments will be higher but you will pay far less in interest rate. If you already took a 30 year mortgage pay it like a 15 year mortgage. Use this online calculator to figure out how much more to add to your payment.
How much of an impact will you have by following this method ?
A $500,000 loan at a 7.25% interest rate with a 15 year will cost you $321,000 in interest payment versus the $727,000 you would pay with a 30 year loan. This will add around $1200 extra to your loan but it will save you almost $300,000.
Pay heavy extra mortgage payments for the first 6 years
The extra payments you pay in the first few years of your loan will have exponential impact on your loan payments. If you pay the same $1200 extra payment to your loan for the first 6 years and continue with your regular payment. You will pay your loan off in 20 years instead of 30. You will also have paid $398,000 in total interest instead of the original $727,000.
This is still a $331,000 SAVING!!! You will also pay off your house 10 years earlier.
What could you do if you did not have a mortgage payment ? Endless possibilities.
Like this post ? Also read: How much money is enough ? or 5 Easy Ways to $1 Million Net Worth
Invest your Extra Payments
The good thing about mortgage payments in the U.S. is, your rate is fixed. Unless you refinance your rate will not change. Even with the 7.25% rate it is a good thing. Which makes this a great hack.
If you invest the $1200 extra payment in a broad market index fund returning 11% for 10 years. Your investment will grow to $240,000. You can dump all of the $240,000 on the 120 th (10 year) payment.
With this method you will pay your house off in 15.75 years and a total interest payment of $383,000. You will have saved $344,000 in interest payments alone.
Full disclosure: this is a riskier method. If there is a market downturn or fluctuation the timing or amount might be off.
Invest Half of your Extra Payments
Just like the previous method, You can invest half of your total extra payments. In this case you would invest $600 for 15 years. With this method, you can pay of your house in 19 years. Your interest savings will be about $200,000. You will not save as much in interest payment as the other type of payments but this will require half the capital as the other.
Just like the payment method before. Market fluctuations will affect your pay off time.
I hope this helps you post helped you understand how mortgage interest rates work. How to reduce the effect it has on your life and how to outsmart the banks. By default these tips and tricks also allow you to pay off your house faster.
