Mortgage prepayment math is complicated
Dear Dr. Don,
I came across an article from Countrywide Home Loans that says a $5,000 prepayment made the first month of the mortgage or refinance would save approximately $40,000 in interest and shorten the length of the loan by five years.
It gave the following example: On a $100,000, 8 percent, 30-year loan, a $5,000 prepayment made the first month of the mortgage would save you $39,296 in interest and shorten the length of the loan by five years. Could you help me understand this?
-- Debbie Down Payment
Mortgage math gets a little complicated because the typical monthly payment is part principal repayment and part interest expense. When you make additional principal payments, you change the mix because you've reduced the loan balance which reduces your interest expense.
That means more of your monthly payment each month goes toward the repayment of principal, and that results in an earlier loan payoff.
You can use Bankrate's mortgage payment calculator and its amortization schedule to do the math for you. I did and here are the two scenarios you describe:
|Loan term (months):||360|
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Additional principal payment
|Loan term (months):||300|
|Add'l principal payment:||$5,000|
|Difference in interest:||$39,296|
|Difference in loan term:||60 months|
It's a little unusual to have the additional principal payment made upfront. If you had the money available at closing, why borrow the funds?
Still, the Bankrate calculator will let you make an additional principal payment with your first mortgage payment. The calculator also has other additional principal payment options you can try out to see how they reduce interest expense and the life of the loan.