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I'm on a 30 year fixed loan with the following properties:

  • 5% interest
  • No penalty for early payments
  • Pretty recent loan, hardly any equity

I'd rather be on a 15 year fixed loan, so that I can pay less in interest, and get more equity sooner. I don't think refinancing would make much sense for me, since my interest rate is not terrible, and I'd have to pay fees.

So my question is: If I just raise my monthly mortgage payment to the right amount, is that basically equivalent to being on a 15 year fixed loan? Is there any drawback to this?

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5 Answers

up vote 8 down vote accepted

To get a good estimate, go here or other similar sites and see. But basically, yes, you can save yourself a whole lot of money just by paying extra every month. One note though, do make sure you are specifying that you want the money to go towards principle, not escrow or toward prepaying interest.

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Thanks - the tip about paying towards principle is incredibly valuable, as I didn't realize that there was a distinction. – Eric Apr 5 '12 at 21:42
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Also - check that there is no prepayment penalty. Some mortgages have a maximum amount you can prepay in a year - because in effect this is cutting into the bank's future profits. – sdg Apr 5 '12 at 22:37
I understand paying more towards escrow (if you expect taxes or insurance to go up, you won't suddenly get hit later), but why would anyone want to pre-pay interest? – Zach Apr 6 '12 at 21:56
No ones ever been able to really explain that one to me but I believe it is only done for weird tax related purposes. – Kevin Apr 6 '12 at 21:57
Check your loan documentation. Mine explicitly stated that additional payment amounts would always be applied to the principle. – Brian Knoblauch Apr 10 '12 at 15:34
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up vote 13 down vote

"Can" is fine, and other answered that. I'd suggest that you consider the "should."

Does your employer offer a matched retirement account, typically a 401(k)? Are you depositing up to the match?

Do you have any higher interest short term debt, credit cards, car loan, student loan, etc?

Do you have 6 months worth of living expenses in liquid funds?

One point I like to beat a dead horse over is this - for most normal mortgages, the extra you pay goes to principal, but regardless of how much extra you pay, the next payment is still due next month. So it's possible that you are feeling pretty good that for 5 years you pay so much that you have just 10 left on the 30 year loan, but if you lose your job, you still risk losing the house to foreclosure. It's not like you can ask the bank for that money back. If you are as disciplined as you sound, put the extra money aside, and only when you have well over the recommended 6 months, then make those prepayments if you choose.

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Add to that: is there somewhere you can put your money where you think you can beat the 5% you're "making" by paying off the mortgage. – yossarian Apr 6 '12 at 17:19
Indeed. But one can suggest that future returns are unknown. That guaranteed returns are not quite 3% for the 15 year or so timeframe. Still, it's a great consideration, as there are funds whose dividend is close to the post tax cost of money to the OP. – JoeTaxpayer Apr 6 '12 at 17:58
Agree. I would be tempted to throw it in a savings account every month and then do a lump-sum payment in 15 years, when the money's there. Between now and then, it's accessible in case (no.. /when/) things hit the fan. – Harv Apr 10 '12 at 18:57
Harv, this is safer, but the savings account isn't going to pay anywhere near 5% interest. So you have to balance risk vs return and choose how much to prepay and how much to stash away. – Mike Kale Apr 10 '12 at 19:56
@MikeKale - in my original answer above, I avoided this aspect of the discussion. But here I'll suggest that a 4% mortgage costs 3% after tax (in 25% bracket), and I'd bet cap gain rates will stay 15% for non-1%ers. So, with the break-even return of 3.5% (to return 3 after tax) and DVY yielding 3.33%, the questions becomes - do you think the DVY top yielders will be flat over the next 15 years? Any return over .17%/yr is profit. That said, the truly risk averse should heed the advise in original answer, then pre-pay. – JoeTaxpayer Apr 10 '12 at 22:45
up vote 8 down vote

You can definitely do it.

But: Refinancing would make more sense to you, you can refinance at no cost and get rates below 4%, so you'll be saving 1% a year, without paying anything extra. If you pay the fees you'll get even lower rates, but then you need to check whether its worth it.

I've just refinanced to a 15 years fixed mortgage at no cost a couple of months ago, and got 3.875% rate (in California), so its definitely worth looking into, don't just dismiss it.

This will limit your flexibility though, because paying 30yrs loan "as if" is much more flexible than committing on 15yes loan - you can always go back to your original payments if you want to spread it out a bit more. You can add a HELOC once you've accumulated some equity to back you up, that's what I did.

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Thanks, great tip - I'll look into that. – Eric Apr 5 '12 at 22:10
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Do you have any tips as to which banks refinance at no cost? – Eric Apr 5 '12 at 22:36
@Eric - most. They compensate themselves by higher rates, but at the level of rates right now even no-cost rates will save you tons of money. Just talk to the mortgage advisors and asks for the no-cost refinancing. I refinanced with Wells Fargo, and a local credit union, both at no costs with rates much lower than what you have. – littleadv Apr 5 '12 at 22:40
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@Eric I recently did a refinance and found the best rates through Google's mortgage site, Zillow also had lenders with similar rates/fees. The no cost refinance I found there was ~3/8 less than the best rate I found else where. Anyways it is worth a look at least. – stoj Apr 5 '12 at 23:56
@stoj, Zillow seems great, thanks. – Eric Apr 6 '12 at 0:17
up vote 5 down vote

The can and the should have been discussed in other answers and comments, and so I will discuss the how. As others have noted, it is important to make sure that the additional money goes to reducing principal and not towards prepayment of interest. Unfortunately, very few bank tellers understand how mortgages work and very few bank officers - even loan officers - understand how mortgages work too. Thus a statement that you want the extra money to go towards principal will likely be met with a blank look. Furthermore, what they do with the money and how it is entered on the bank books that afternoon when the transactions are recorded may have no resemblance to what was discussed and agreed to earlier in the day. Based on my personal experiences and many arguments with banks about how they handled my prepayments and how interest was computed, I would recommend the following (which is easier now that automated payments are possible for the standard monthly payment and additional payments are possible via electronic funds transfer).

  • Make sure that automated payments are made on the day that the payment is due, not at the end of the ten-day grace period that banks love to grant you for making the monthly payment. Yes, there is no penalty for late payment as long as you pay before the end of the grace period, but interest continues to be charged and so more of each graciously delayed payment goes to interest and less towards principal.

  • Make the additional payment on the same day as the standard monthly mortgage payment is made. This ensures that at worst just one day's interest is owing when the additional payment is made. Also, payment in the middle of the monthly cycle is an almost sure way of getting ripped off on the interest because the bank's computers will post the payment in the manner most favorable to them, and usually contrary to the terms of your mortgage. I have complained to banks about mishandled mid-month payments and won every time, and on many occasions the bank officer would grudgingly say "We have always done it this way and nobody ever complained till you did today." I doubt very much if the bank's programs got changed as a result of my complaints. If you are not sure how mortgages work and how interest is calculated or don't have the time or inclination to go hassle with the bank each time but do prefer not to get ripped off, make the payment as described: on the dot and at the same time as the regularly scheduled monthly payment.

  • The amortization schedule that the bank should have given you shows how much the principal amount is after the monthly payment is made on each due date. Assuming that you have not been taking advantage of the grace periods and so the schedule is correct, make an additional payment not of a round sum but an exact amount (down to the last penny) that will jump you from principal owing after today's regular payment to principal owing after the regular payment N months from today. Here of course you choose N based on how much extra money you were planning on paying towards your mortgage. By making the extra payment, you will effectively have cut the length of the mortgage by n months and the same amortization schedule will apply over the shorter period. Since very little of the principal is repaid in the early life of the mortgage, an additional principal-only payment can reduce the length of the mortgage by years. Paying a specific amount that matches the amortization schedule also helps if you ever need to hassle with the bank. It is their print-out you are arguing from, and not trying to explain to a clueless bank officer how the bank did not compute interest correctly after you paid $1500.00 extra at beginning of last month.

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If someone ever said to me "We have always done it this way and nobody ever complained till you did today" in a context like that, I'd respond with, "sir, did you just admit that it has always been the policy of this bank to apply payments in a manner inconsistent with its contractual obligations?" You phrase it like that, then suddenly it's not just your complaint they have to deal with if you're unhappy, but the possibility of a class-action lawsuit. Then they're a lot more likely to take your complaint seriously, to avoid a much bigger mess down the road. – Mason Wheeler Apr 6 '12 at 21:40
@MasonWheeler I would be surprised if a lawyer would be willing to take on a class action suit over this matter. The number of mortgages held by a bank is not too large (Bank of America, Citibank etc might be a different category), prepayments are relatively few, each mortgage contract is different (making class action difficult), and the remedy --making each plaintiff whole by refunding the excess interest charged-- is far cheaper than defending each law suit separately or a class-action suit (if the judge allows consolidation into a class-action suit). – Dilip Sarwate Apr 7 '12 at 2:08
Dilip - you're suggesting here that if one pays, say 10 days late (given the grace is 15) that they miss the amortization schedule, that at the end of 30 years, there's an accumulated amount of interest on those 10 day gaps? Have you witnessed this or are you suggesting it's possible? I've tinkered wit my payments just to experiment, and see the balance identical to the amortization table whether I pay 14 days late or 10 days early. – JoeTaxpayer Apr 7 '12 at 20:27
@JoeTaxpayer Each mortgage contract is different and the last one I had was over twenty years ago. At that time, at least, a payment received after the due date but before the expiry of the grace period did not incur a penalty for late payment. However, the amortization schedule was not followed in that the interest part of that payment was for one month + x days instead of one month, and so the reduction of the principal amount was less. Thus the effect carried over till the mortgage was paid off. The contracts specifically said payments would be applied to interest due first, and .... – Dilip Sarwate Apr 7 '12 at 21:23
....and the principal afterwards; and interest due was interest computed from the day of the last payment till the day of the current payment. If one consistently paid x days after the due date, the effect would be small, but there would be an oddball figure, less than the full monthly payment, in the last month. More recent mortgages may have different terms; I wouldn't know. – Dilip Sarwate Apr 7 '12 at 21:28
up vote 4 down vote

You definitely can under those conditions. Just be very careful to specify that you are making extra principal payments.

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