Many Americans enjoy home ownership, and along with it, a mortgage from a lender at a certain Annual Percentage Rate (APR).
Many of the mortgage holders pay just their monthly dues, a portion of which goes to the mortgage insurance, a portion (generally large) goes towards interest, a portion goes to the principal, and the remaining goes towards escrow - which takes care of your home property taxes and home insurance.
Some homeowners like to pay off their mortgage sooner than the standard 30 years or 15 years, so they either round off their monthly payments to the nearest hundred or whatever higher amount they are comfortable with. For example, someone with a monthly mortgage payment of $2,100 may pay off $2,500 or $3,000, or a flat $100 extra.
If you regularly pay off an extra amount on top of your monthly mortgage, read on. There is a lesser known secret that you can use to pay off your principal first with the extra amount.
As you all know, many banks use your previous month's ending balance (or the current month's starting balance) to calculate the monthly interest. For example, say, the total principal balance of your mortgage as of August 31, 2017 was $450,000. Let's say your APR is 4% annually. and your monthly mortgage amount is $2,700. When you make your regular monthly payment of $2,700 on September 01, 2017, the banks always calculate the interest first.
The monthly interest on $450,000 at 4% is $450,000 * (4/100) * (1/12) = $1.500. (As you can see, 4% or 4/100 is the interest annually, and 1/12 helps me get the interest per month). Assuming, $150 for mortgage insurance, and $300 for escrow, the remaining amount ($2,700 - $1500 - $150 - $300 = $750) goes towards your principal. (Just compare this: $1,500 goes towards interest, versus just half $750 going towards principal!) Your new outstanding principal balance is now $450,000 - $750 = $449,250. (Out of the $2,700 you paid, you just made a dent of $750 in your principal).
If you are the type of person who wishes to pay off your mortgage sooner, you may round the $2,700 to say $3,000 and add another $2,000 to it to make it an even $5,000. With this, the additional $2,300 goes towards your principal, and your new outstanding principal balance is $449,250 - $2,300 = $446,950. Any additional regular payment you make uses this amount to calculate interest for the subsequent month.
Let's say you are fortunate enough to have a mortgage with a bank that uses your current principal balance to calculate your interest. When I say current, it means the principal balance as of "now", not the ending balance from the previous month. Let's see, how the same $5,000 monthly payment in September pans out. With such a bank, using the same example, the technique is to make the $2,300 principal payment first on September 01, 2017. This has to be done separately and should be the only mortgage transaction for the day. I will explain why in a minute.
Let's start with the same set of numbers, $450,000 outstanding principal balance as of August 31, 2017 and your $2,300 principal only payment on September 01, 2017. Your new outstanding principal balance as of September 01, 2017 is now $450,000-$2,300 = $447,700.
Now, on September 02, 2017, make your $2,700 regular payment. Your interest is now calculated on $447,700 and not $450,000.
Your new interest is $447,700 * (4/100) * (1/12) = $1,492.33. Assuming, $150 for mortgage insurance, and $300 for escrow, the remaining amount ($2,700 - $1,492.33 - $150 - $300 = $757.67) goes towards your principal.
Your new principal balance is $447,700-$757.67 = $446,942.33 as of September 02, 2017, and if you do not make any more payments, this becomes your monthly ending balance, and the whole cycle continues.
Let's look at this again:
If you had made the full $5,000 payment on September 01, 2017, your new principal balance is $446,950.
If you split the $5,000 with the principal only on the first day, and your regular $2,700 payment the subsequent business day, your new principal balance is $446,942.33, now $7.67 lower.
Now, this $7.67 does not seem a lot due to the high mortgage amounts, but if you keep prepaying the principal first and lowering it, and then making your regular payment towards the end of the month, you will be paying down the mortgage sooner.
So, the next time you hand in the principal and regular payment check as a single amount, just think about this strategy.
Let me know how this works out for you.
Many of the mortgage holders pay just their monthly dues, a portion of which goes to the mortgage insurance, a portion (generally large) goes towards interest, a portion goes to the principal, and the remaining goes towards escrow - which takes care of your home property taxes and home insurance.
Some homeowners like to pay off their mortgage sooner than the standard 30 years or 15 years, so they either round off their monthly payments to the nearest hundred or whatever higher amount they are comfortable with. For example, someone with a monthly mortgage payment of $2,100 may pay off $2,500 or $3,000, or a flat $100 extra.
If you regularly pay off an extra amount on top of your monthly mortgage, read on. There is a lesser known secret that you can use to pay off your principal first with the extra amount.
As you all know, many banks use your previous month's ending balance (or the current month's starting balance) to calculate the monthly interest. For example, say, the total principal balance of your mortgage as of August 31, 2017 was $450,000. Let's say your APR is 4% annually. and your monthly mortgage amount is $2,700. When you make your regular monthly payment of $2,700 on September 01, 2017, the banks always calculate the interest first.
The monthly interest on $450,000 at 4% is $450,000 * (4/100) * (1/12) = $1.500. (As you can see, 4% or 4/100 is the interest annually, and 1/12 helps me get the interest per month). Assuming, $150 for mortgage insurance, and $300 for escrow, the remaining amount ($2,700 - $1500 - $150 - $300 = $750) goes towards your principal. (Just compare this: $1,500 goes towards interest, versus just half $750 going towards principal!) Your new outstanding principal balance is now $450,000 - $750 = $449,250. (Out of the $2,700 you paid, you just made a dent of $750 in your principal).
If you are the type of person who wishes to pay off your mortgage sooner, you may round the $2,700 to say $3,000 and add another $2,000 to it to make it an even $5,000. With this, the additional $2,300 goes towards your principal, and your new outstanding principal balance is $449,250 - $2,300 = $446,950. Any additional regular payment you make uses this amount to calculate interest for the subsequent month.
Let's say you are fortunate enough to have a mortgage with a bank that uses your current principal balance to calculate your interest. When I say current, it means the principal balance as of "now", not the ending balance from the previous month. Let's see, how the same $5,000 monthly payment in September pans out. With such a bank, using the same example, the technique is to make the $2,300 principal payment first on September 01, 2017. This has to be done separately and should be the only mortgage transaction for the day. I will explain why in a minute.
Let's start with the same set of numbers, $450,000 outstanding principal balance as of August 31, 2017 and your $2,300 principal only payment on September 01, 2017. Your new outstanding principal balance as of September 01, 2017 is now $450,000-$2,300 = $447,700.
Now, on September 02, 2017, make your $2,700 regular payment. Your interest is now calculated on $447,700 and not $450,000.
Your new interest is $447,700 * (4/100) * (1/12) = $1,492.33. Assuming, $150 for mortgage insurance, and $300 for escrow, the remaining amount ($2,700 - $1,492.33 - $150 - $300 = $757.67) goes towards your principal.
Your new principal balance is $447,700-$757.67 = $446,942.33 as of September 02, 2017, and if you do not make any more payments, this becomes your monthly ending balance, and the whole cycle continues.
Let's look at this again:
If you had made the full $5,000 payment on September 01, 2017, your new principal balance is $446,950.
If you split the $5,000 with the principal only on the first day, and your regular $2,700 payment the subsequent business day, your new principal balance is $446,942.33, now $7.67 lower.
Now, this $7.67 does not seem a lot due to the high mortgage amounts, but if you keep prepaying the principal first and lowering it, and then making your regular payment towards the end of the month, you will be paying down the mortgage sooner.
So, the next time you hand in the principal and regular payment check as a single amount, just think about this strategy.
Let me know how this works out for you.
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