Maximizing Savings in a High-Interest Rate Environment

[Brad Roche]

In a high-interest rate environment, every penny counts when it comes to managing your finances. One area where this is particularly true is in paying down your mortgage. For most people, their mortgage is their largest monthly expense, and the interest rates can significantly impact the overall cost of homeownership. This article explores the benefits of making additional principal payments on your mortgage, using a $250,000 loan at 7.5% interest for 30 years as an example. By paying an extra $200 per month towards principal, you can effectively reduce your interest rate to 6.39%, resulting in substantial long-term savings.

Understanding Mortgage Basics

Before delving into the advantages of paying extra towards your mortgage, it's crucial to grasp the fundamentals. In a fixed principal and interest mortgage, such as the one mentioned, your monthly payment remains the same throughout the loan term. However, the allocation between interest and principal changes over time. In the early years, a significant portion of your payment goes towards interest, while in later years, more goes towards principal.

THE BENEFIT OF PAYING EXTRA PRINCIPAL

Interest Savings:

In a high-interest rate environment like the 7.5% scenario we're considering, a substantial amount of your monthly payment goes towards interest. For instance, with a $250,000 loan, your monthly payment would be approximately $1,748 initially. In the first month, roughly $1,562 goes towards interest, and only about $186 reduces the principal balance.

Shortened Loan Term:

When you make extra principal payments, you're effectively reducing the outstanding balance of your mortgage. Over time, this results in a shorter loan term. In our example, adding an extra $200 per month would enable you to pay off your 30-year mortgage in approximately 22 years and 6 months. This not only saves you on interest but also means you'll own your home outright much sooner.

Long-Term Savings:

The long-term savings from making extra principal payments can be astounding. By reducing your effective interest rate and shortening your loan term, you can potentially save tens of thousands of dollars in interest payments. In our example, over the life of the loan, the savings could amount to over $90,000!

In a high-interest rate environment, managing your finances wisely is essential. One way to maximize your savings and reduce the overall cost of homeownership is by making extra principal payments on your mortgage. By doing so, you can significantly lower your effective interest rate, shorten your loan term, and save a substantial amount of money in interest payments. So, if you find yourself in a high-interest rate scenario, consider the benefits of paying a little extra towards your mortgage each month; the financial rewards will be well worth it in the long run.

The APR describes the interest rate for a whole year (annualized), rather than just a monthly fee/rate. The APR allows a borrower to compare costs of credit because it factors in term, interest rate and fees associated with the loan. The above use is for sample purposes only and should be reviewed with your loan originator for specifics to your mortgage.

*Rates effective Sept 26, 2023. Rates quoted are estimates and based on a 740 credit score. Loan-to-Value’s (LTV) of 80% for Conventional Loans, 100% for VA Loans, and 96.5% for FHA Loans. This payment does include taxes and homeowner’s insurance is an estimate; your actual payment will be higher. An annual and monthly mortgage insurance premium may be required and will vary depending on the loan characterization. Payments and rates may vary based on borrower’s credit score, actual closing costs and other variables. Depending on your situation, flood, property hazard, and mortgage insurance may be needed, which could increase the monthly payment and Annual Percentage Rate (APR).

USDA - * This loan amount does not include the upfront guarantee fee, your loan amount will be higher. 100% financing, no down payment is required. The loan amount may not exceed 100% of the appraised value. Loan is limited to the appraised value without the pool, if applicable.