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February 05, 2007


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I've always wondered how the math on this works. Since a mortgage is amortized, the predetermined interest is split up amongst your payments when you start the loan, and paying off early saves you spent interest by cutting payments off the end. So is there any benefit to paying extra early as opposed to saving up until you have enough to pay the whole thing off in a lump sum?

In other words: does the interest paid on subsequent payments lower if you make additional payments early on? or does it go back to your orginal payment schedule, but take the prinicpal payments off the end of the loan?

P.S. Don't give me the "saving up requires more discipline than you have" speech. I'm strictly concerned with the technical aspect of the question, not the application.

Cory --

Each loan has different terms (so check yours for details), but generally, yes, you'll save more in interest in the earlier payments.

I just had a co-worker tell me he's put in extra payments for 2-3 years and he's already knocked 10 years off his mortgage.

I'm thinking about putting extra money toward my mortgage for an entirely different reason. My wife and I do not have 20% equity in our home yet, so we are paying $63 a month for PMI. The faster we get to 20% equity, the faster the PMI will be removed, saving us that $63 per month.

When you make additional payments on a mortage, you eliminate payments in the middle. For example, if you look at your amortization schedule and see that the portion of the payment that would go against the principal is $100, then adding $100 to this month's payment would eliminate next month's payment from the schedule, and move all the remaining payments forward by one month. (You still have to make a payment every month even though you've paid ahead on the principal).

So any payments you make early in the loan are in effect get compounded interest at whatever the mortgage rate is. In this example, the $100 would grow to the value of one payment at the time the final payment would be due. To get your $100 + compounded interest back you either have to sell your property or stay in it long enough to where you're not having to make mortgage payments because of the additional payments against the principal you made earlier.

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