Written by Trent Hamm, The Simple Dollar is a popular personal finance blog that chronicle's one man's road back from overwhelming debt to financial security. Hamm declared the contents of the blog to be in the Public Domain in 2008 and available for sharing when attributed properly. We will share a couple of posts a week.
Let’s look at a “typical” mortgage. Right now, the average American mortgage is $235,000, so let’s use that as our baseline. The Seattle Times reports that, right now, the average 30 year fixed mortgage rate is 3.42%.
So, let’s use those numbers. We’ll look at a 30 year fixed mortgage at 3.42% that borrows $235,000.
Under those conditions, a person will be paying $1,044.79 per month for the next 360 months. That’s assuming they make the minimum payments on that mortgage over the entire term. They end up paying a total of $141,123.93 in interest over the course of the loan.
Now, what if a person adds just $1 as an extra payment each month for the entire loan? Each month, they pay $1,045.79. What changes?
Well, the final payment drops to $419.19. By putting in just $1 extra each payment – a total of $359 – you save $626.60 on that last payment.
What if a person adds just $5 as an extra payment each month for the entire loan? Each month, the total payment is $1,049.79. What does that look like?
In that case, you don’t even need to make your last two payments, and the payment before that is only $25.20. Over the course of the loan, you pay in $1,785 extra, but you end up with $3,109.17 in payments you don’t have to make at the end of the loan.
What’s happening here is that every dollar you pay extra on your mortgage effectively “earns” interest at a rate equal to your mortgage interest rate for the rest of your mortgage.
So, if you pay $1 extra on that first payment, your dollar will earn a 3.42% return tax free over the next twenty nine years and twelve months. (You receive that return in the form of having the home paid off earlier than you otherwise would or if you sell the house before the mortgage is finished.)
Could you do better than that with your dollar? That’s a better return than your savings account will give you right now. It’s better than inflation right now, which is below 3% by most calculations. It’s probably not as good as the return you’d get in the stock market over that period, but the stock market also causes risk and it also has tax implications.
The question you really have to ask yourself is will you miss that extra dollar or that extra five dollars? What would you do with it that would really make an impact in your life?
If you don’t have a productive use for that money, it makes sense to simply add it to your mortgage payment. It earns a steady and safe return over the long haul.
It doesn’t take much to add up to a big difference as long as you keep doing that little thing regularly.