In my years as a financial planner, one particular story relating to home ownership comes to mind, here’s a cautionary tale:
Early in my career, a young woman approached me complaining that she decided to bring down her mortgage by paying much more than her monthly mortgage payments, but she quickly saw that her mortgage was not going down relative to her over payments. You are probably wondering why as well. Let me explain the logic behind my clients actions with the following example:
Mortgage: $100, 000
Length of the mortgage: 30 years
Monthly mortgage payments: $599.55 ($500 interest + $99.55 principal)
Now, if you decide to pay $1,000 one month, then you have paid $500 in interest and $500 in principal. As a result, your mortgage has gone down by $500, instead of just $99.55. With a lower principle, you can thus pay down your mortgage faster.
Unfortunately, you have to let the bank know of your plans to pay down your mortgage. In my past clients case, her over payments simply carried over to the next mortgage payments. So, if you paid $1000 instead of the $599.55 mortgage payment, the $400.45 would go to your next mortgage payment of $599.55 and you would have to pay $199.10. Your mortgage payments have not actually changed and the length of the mortgage payment is still 30 years.
Moral of the story: If you have extra cash and want to pay down your principal at anytime, you must let your bank know.
Feel free to ask other questions on home ownership.
Rosie Ogang, PFP, CPA, CMA