Does your employer give a year-end bonus? Many employers do and it’s usually based on departmental or companywide goals being met. Also, some companies are nice enough to time this bonus right around the holidays when consumer spending is highest. The next dilemma is what to do with this unexexpected source of cash? Do you
- put it towards Christmas presents?
- pay off previous debt or loans?
- finance that home improvement?
- put it into savings or investments?
- apply it to your mortgage principle?
I’d like to discuss what the possible financial benefits would be if you put that bonus money towards the principle owed on your mortgage. First some assumptions: your mortgage is $150,000 over thirty years with a 6% interest rate. Excluding real estate taxes the princple and interest payment would be $899 per month over those thirty years. Below are the possible scenarios.
Sending just one extra payment to your lender (in our example it’s $899) in December on the first year of your mortgage slices five months of payments on the mortgage. In other words, that $899 turns into five months of mortgage payments over thirty years. Put another way, you are basically turning a one-time investment of $899 at 6% over thirty years into $5169 which is between five and six months of mortgage payments.
Now let’s suppose you were discplined enough to send that $899 in December each year to your lender. It computes to $899 sent to your lender each December until the mortgage is paid off. In this case it translates to paying off the mortgage exactly five years, three months early. So, twenty-four payments of $899 (in years one through twenty-four) shave off sixty-three months of the mortage (five years, three months = sixty-three months). Wow, you turned twenty-four payments into sixty-three payments just by using time on your side.
Next let’s get a little crazy. What if you made double payments on that thirty-year loan? You’d pay off the home in a little over nine years. Of course, the average consumer would have a tough time paying double-payments on any mortgage but it’s certainly possible with a lot of discipline.
All of the above examples confirm one of Albert Einstein’s greatest quotes: “the most powerful force in the universe is compound interest.” Whether you use that compound interest with one extra payment, one extra payment per year or an extra payment every month it gathers enormous momentum over time.
In my case, I am currently in year four of a thirty-year mortgage. When I called my mortgage lender recently and asked what effect an extra payment would have on the pay-off date of my mortage the customer service person replied that it would shave four months off the end of my mortage. Thus, the title of this article….I would get four times my money back from making one extra payment.
Let’s summarize the major points of this article:
- As with all investments, time is your best ally. The more you have of it the more power it produces.
- In some cases one extra mortgage payment made early enough in the life of the mortgage can shave four to five months off the mortgage.
- One extra payment made per year can shave over sixty months off the mortgage.
- Double payments on a thirty year mortgage can shave nearly twenty-one years off of a thirty-year mortgage.
Finally, one important note is that you may find better uses for that extra cash rather than putting it into your mortgage. Invested in a good mutual fund the money could grow twice as fast as put towards your mortage. Just another financial nugget to digest.