August 08: Payback time

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Just because you’re successfully weathering the current credit crises, armed with your reliable FHA-backed loan and your unsexy but stable fixed interest rate, doesn’t mean you should rest easy. You are losing money just sitting there! By the time you make that last mortgage payment decades down the road, you ultimately may pay more than twice the original amount of the loan.

O.K., brace yourselves, we’re going to discuss a little math by way of example. Here goes: Let’s assume you took out a 30-year mortgage of $200,000 at a fixed rate of 6 percent. Using a typical amortization schedule (we used the one provided on the website of local mortgage consultant Lee McAllister at ctxloanofficer.com/leemcallister), we discovered that by the time you make your last payment, you will have repaid the bank the principal amount plus an additional $231,676 in interest payments!

When you look at long-term debt this way, it’s ugly, right? Makes you want to raise your fist at the bank man, doesn’t it?  Well, slow down. Math and time work just as much for you as they do for him. If you’re able to make some extra payments on your principal, you can greatly reduce your total interest bill as well as shorten the life of the loan.

“Just because it’s a 30-year mortgage doesn’t mean you have to be committed to it for 30 years—I encourage all of my buyers to visit caar.com’s mortgage calculator to see how additional payments can shorten the term,” says local RE/MAX Realtor Julie Kuhl. And according to McAllister, “one extra mortgage payment a year shortens a 30-year mortgage to 23 years.”

And even a little extra goes a long way. Using the same example above, let’s assume you pay an extra $50 a month. By the end of the mortgage term, you will have reduced your total interest payments by $27,679 and shortened the loan by three years!

Of course, nothing involving banks (or math, for that matter) is ever easy, so don’t stop reading just yet. Before you go skimping on your lattés and throwing every extra dollar and all your hard-earned employment bonuses toward your monthly mortgage payments, keep the following issues and pitfalls in mind:

Your savings plan

McAllister says that if you’re a disciplined saver, one school of thought suggests that rather than putting extra cash toward your mortgage now, you should save and invest it. That way when the little nest egg grows, you can make a large, lump sum payment on your mortgage. If you’re not so skilled in the savings department, however, throwing your extra cash at the mortgage is probably a much better use of the funds than, say, blowing it on beers or something.

Prepayment penalties

Lenders would love to draw out your interest payments as long as possible, and some will penalize you for paying off the principal early. McAllister says that most new loans of the traditional 30-year-fixed variety don’t include this type of penalty, but definitely read the fine print.

Biweekly mortgages

Several financial service companies out there will help you formalize an accelerated payment schedule in which you split your monthly mortgage minimum in half and pay it in biweekly installments. This generally results in one extra principal payment every year. The problem is that these companies (and even your lender) typically charge a fee to formalize a schedule like this.

“You should never pay a fee to establish an accelerated schedule when you can accomplish the same thing yourself,” says McAllister. If you want to make a regular habit of biweekly payments, her advice is to make your first full mortgage payment, then split the figure in half and just take it upon yourself to pay that amount every two weeks.

Separate checks

Whether you’re sending biweekly payments or simply adding a few extra dollars to your payment every month, you should clearly indicate in a note and, in the case of extra payments, on a separate check that the purpose of the irregular payment is to pay down principal. Otherwise, McAllister says, the bank may put overpayments in escrow for the next month’s bill, in which case you’ll still get hit with the interest accrual.

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