Dear Dr. Don,
I am getting ready to have a new home built. I'm considering a 30-year fixed-rate mortgage at 6 percent for \$360,000. I am 49 years old, and what I am trying to do is pay the loan off by the time I am 65 years old (when I retire), but if I make the loan term 15 years, the monthly mortgage payment is too high.

I heard on a TV finance program that if I were to make one extra payment each year of the 30-year loan, that I could cut eight years off the life of the loan. My question is: If I make two extra payments each year, would it cut the life of the loan by another eight years?

This strategy seems to cost me less each month than if I were to set up a 15-year mortgage. Also, what about paying bi-monthly? This also seems to save on interest. Any info you can give me is greatly appreciated! I have a hard time understanding the math involved to prove this is a better way to go.
Sincerely,
Carol Calculator

Dear Carol,
Making additional principal payments can shorten your loan by years, but you're not going to be able to reduce a 30-year fixed-rate loan down to 16 years by making additional principal payments each year equal to two monthly payments.

Let's start out by comparing the 30-year loan with the 15-year loan without making any additional principal payments.

 Loan comparison 30-year fixed 15-year fixed Difference Loan amount: \$360,000 \$360,000 Interest rate: 6.00% 5.35% Loan term (months): 360 180 Monthly payment \$2,158.38 \$2,912.92 \$754.54 Total payments: \$777,017 \$524,326 Total interest: \$417,017 \$164,326 \$252,691

You pay an extra \$755 a month over its 15-year life or \$135,817, but it saves you (pretax) \$252,691 in interest expense and 15 more years of mortgage payments. If you can use the mortgage interest deduction on your taxes, the savings is less because you have less interest to deduct. A good back-of-the-envelope calculation is to assume that your savings after-tax is equal to about two-thirds of the pretax savings.

If you can't make a 15-year fixed-rate loan work in your monthly budget, the alternative is to take out a 30-year loan and make additional principal payments. There's no real need or use in having a biweekly mortgage if you have the discipline to make the additional principal payments on your own.

Bankrate's Mortgage Calculator will calculate the mortgage payment on your loan and then let you experiment with different additional principal payment strategies to see how it shortens the loan term. Update the amortization schedule portion of the calculator and it will show the total interest expense for the loan.

The table shows two strategies for making additional principal payments. The first has you making an additional principal payment equal to one-twelfth of a monthly mortgage payment each month. The second strategy doubles that to one-sixth of a monthly mortgage payment.

 Additional payment strategies 30-year fixed plus 1 extra payment 30-year fixed plus 2 extra payments Loan amount: \$360,000 \$360,000 Interest rate: 6.00% 6.00% Loan term (months): 295 252 Monthly payment \$2,158.38 \$2,158.38 Additional principal payment \$179.87 \$359.73 Monthly payment \$2,338.25 \$2,518.11 Total payments: \$688,617 \$633,444 Total interest: \$328,617 \$273,444

Even by making two extra mortgage payments a year, your loan wouldn't be paid off until April 2024, but it would save you \$143,574 in interest expense (pretax) when compared to the original 30-year fixed-rate loan. Making an extra payment each year shaves 5.5 years off your loan vs. the eight years you heard on the TV show.

Finally, your desired loan amount makes your mortgage a jumbo or nonconforming loan in most markets. The 2003 single-family loan limit is \$322,700. That maximum loan amount is 50 percent higher in Alaska, Hawaii and the U.S. Virgin Islands.

 -- Posted: May 6, 2003

 Bankrate.com's corrections policy

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