37

I can pay $1200 extra once a year or $100 every month - which is better? The first one does sound better, but for a 30 year mortgage, is it that significant? Say the mortgage is for $200,000.

Thanks.

  • 5
    When during the year can you pay the extra money? – jprete May 2 '11 at 3:31
53

In general, the earlier you apply a payment, the better, because future payments will include less interest and more principal (the mortgage balance is lower, so less interest has accrued). If you have the $1200 now, then it makes sense to put it on the mortgage immediately. However, if you'll have to save $100 per month for a year and then pay it on the mortgage, you'd be better off paying $100 per month straight to the mortgage.

  • 1
    Financial advisors seem split on the advice of paying early vs on-time. If you take into account that the interest is tax deductible and the inflation of the dollar, the difference could be negligible. Investors could even come out ahead paying on-time rather than early, but again since we're bracketed within 1 year spans, gains would be small. – hyperslug May 2 '11 at 3:14
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    Most of the people recommending against pre-payment are using the straw man argument that prepaying your mortgage means that you aren't saving for retirement. You also need to think about money in terms of cash-flow as well as net worth. Say you're 35 and buy a home... do you really want to be burning cash at the same rate as you are today when you are 65? Prepayment results in a free & clear house around age 56-58. – duffbeer703 May 2 '11 at 4:29
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    @duffbeer703 - but you cannot eat your house if at retirement its worth less than you owe like it is for millions now :p. You are correct if we are to only consider the details given in the question. Otherwise I think you argument only works if you are young and can pay off the house before retirement. What about all the lost years that a person could miss out in filling their IRA in exchange for paying off the house, you cannot put it in later. For this reason the question is not simple to answer. – Tim Santeford May 2 '11 at 20:51
  • @Tim Santeford: You have a point, but keep in mind that your mortgage is usually a quantifiable thing. IRA and 401k returns are highly variable and depend on your ability to make good investment decisions. That doesn't always happen... many people dumped their 401ks into stable value funds after Lehman collapsed and left them there -- those poor folks made a decision that cost them years of returns. – duffbeer703 May 4 '11 at 3:50
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    The real question on prepayment is what you're going to do with the money if you DON'T put it into the house. If you've got investments which are returning more interest than the loan is consuming, you may want to leave the money there as a leveraged investment. Of course that does involve some risk; it's up to everyone to decide their own risk-tolerance level. – keshlam Nov 24 '14 at 14:30
11

From a purely fiscal point of view, you will be better off paying $1200 off upfront instead of $100 a month. This is because the money is in your account earlier which lowers the amount you have to pay in interest for that whole year.

To illustrate, you can go to this site.

http://www.mortgageseek.com.au/mortgage-calculators/calc-additionalpayment.php

Under these conditions

Loan Amount : 200,000 Interest rate : 6.5%

Under 12 $100 payments per year, you will save $55,945.77 and 5 years and 7 months in the life of the whole loan.

If you pay one $1200 payment every year, you will save $59,549.80 and 5 years and 10 months.

So you'll save about 4000 in 24 years.

9

The best strategy is to have 1 year of mortgage payments in savings. This way, if you get laid off, or some other even occurs that precludes you from being able to pay normally, you won't pay late, and you won't affect your credit.

Between the low interest rate and the tax credit, borrowing for a mortgage is very inexpensive. Only make efforts to pay off your mortgage early once your other debts are paid in full. Student loans also. They may seem to be of lower interest rate, but because you can't eliminate them in bankruptcy, they are very dangerous should something happen to your income stream.

Finally, as the others have said, it is most likely not significant.

  • 2
    This is a great reminder of why it is important to have a good emergency fund. – Stainsor May 2 '11 at 18:04
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    +1 Agreed, All those extra payments wont help you when you face loosing the house due to unexpected loss of income. Better to fund an emergency fund, payoff higher interest loans, max out your IRA, then pay extra on the mortgage. – Tim Santeford May 2 '11 at 20:32
4

You didn't offer the rate or balance. At 5%, the $1200 paid in january would put you to the better by $60. If paid over the year, $100/mo, you're $30 to the better that year. Either way, subsequent years produce a compounding on the $60 interest. To answer just your question - if your intent is to pay early, earlier is better.

Some banks have been known to mis-apply the extra payments, so regardless of what you chose to do, be sure you track your balance.

Keep in mind (this now veers off the original question) paying early is the choice to invest in a guaranteed fixed rate, for the remaining life of the loan. The rate of course, is your mortgage rate. I'm compelled to advise that you first be sure you are depositing to your 401(k) up to your company match, if any, then have all other debt paid off, and as others said, emergency funds saved. I've seen the crazy notion that "$100 to my mortgage will save me $400 at the end of my loan, but paying my 18% credit card only saves me $18." Nonsense.

0

In the grand scheme of things, it doesn't really make a material difference. The best strategy is the one that you'll actually do!

Another popular pre-payment strategy is to make bi-weekly payments.

  • -1 Doesn't answer the question, and raises straw men with the bi-weekly payments. – Erick Robertson May 2 '11 at 13:00
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    @Erick Robertson: The question asked "is that significant?". My answer addressed that, and offered an alternate, similar strategy. Do you actually know what a "straw man" is? – duffbeer703 May 2 '11 at 13:09
  • With a 7% mortgage rate it looks like the difference will be just under $50 by the end of the year. (Not counting tax differences.) Of course that $50 off of your mortgage principle could become $200-$300 over the life of a mortgage. It all depends on where you place your threshold for "not significant." – Stainsor May 2 '11 at 18:06
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    A $200k mortgage at 7% results in $591k in total payments if paid on schedule. $300 represents 0.05% of that worst case... I think that qualifies as immaterial by any standard. – duffbeer703 May 4 '11 at 3:54
-2

In short, the earlier you make the extra payments, the better it is.

Here's a quick illustration of 5 extra payment scenarios using a 30-year $200K mortgage @ 5% interest rate starting from Jan 2013:

1) No extra payments : http://usmo.org/1zSdX3t

Total Interest Paid: $186,511.57

2) Pay $100 extra per month starting from the first month of your mortgage : http://usmo.org/1hYLfsF

Total Interest Paid: $149,442.54

3) Pay $1200 extra at the end of the year, starting from first year of the mortgage : http://usmo.org/19JnURO

Total Interest Paid: $150,787.53

4) Pay $1200 extra at the beginning of the year, starting from first year of the mortgage (unlikely scenario because you would probably include it in the down payment): http://usmo.org/1hYLYKo

Total Interest Paid: $148,087.12

5) Pay $1200 extra at the beginning of the year, starting from second year of the mortgage: http://usmo.org/1hYLwvP

Total Interest Paid: $151,024.59

6) Accelerated bi-weekly payment without extra payments

Total Interest Paid: is $152,154.98.

  • 3
    Include the savings for each scenario in the text of the answer, otherwise if the links are ever broken the answer will be worthless. – mhoran_psprep Nov 21 '13 at 11:05

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