Paying off your mortgage faster- the scenarios

This particular article of mine is very long and I hope, valuable to you as a reader. It will go into depths with the numbers, figures and examples. If you need to take a break in between, I suggest you do that. I would value a comment feedback if you found this helpful, and if you comment with an outline of your own mortgage structure, that would be interesting.

There are pros and cons of paying off the mortgage faster, however this particular article of mine is only concerned with how to pay off your mortgage faster and what the financial effects are if you pursue various repayment options.

Decades ago, housing was 2-3 times the average annual wage, in modern days, housing is now 5-6 times and more the average annual wage.

Because of this, it’s more important than ever to know how to organize your payments so that you can pay your mortgage off faster, rather than letting the repayments consume the next 25-30 years of your life. Why would the banks advise you how to pay off your mortgage faster? There would be less profit for them if they did that.

If you are using property as a wealth creation vehicle, then this article isn’t strictly appropriate for you. Using property as a vehicle to build wealth, would involve maximizing your investment loans (tax deductible), leverage (LVR) and the amount of properties under your control and it does not necessarily include the goal of paying off your mortgage loans faster.

Paying off any non-deductible debt such as the mortgage on your principal place of residence (PPOR), that is, the home that you live in right now, can be easy by understanding how a mortgage works. You can knock anything from 5-25 years off your mortgage. There are books out there that boast that they paid their mortgage off in 3years. This is possible and achievable if your mortgage isn’t more than 3 times your annual income! Most mortgages though, with the right payment structure setup, can be paid off within 3-10 years.

If you earn $60,000 per annum, and your mortgage is $300,000 then it will take more than 5 years to pay off. Why? $60,000 income, deduct taxes, living expenses, mortgage interest and you can already see that you can’t pay it off in 5 years unless something changes – either you earn more or you spend less. Your target could be to pay it off in 5-10 years. Set reasonable goals and targets.

The ability to pay off your mortgage quickly depends largely on your income but you can learn a few repayment techniques which can help you pay off your mortgage faster, regardless of your income. See my article about “15 Tips on paying off your mortgage faster” filed under the label “All about mortgage loans.”

Once you understand how the loan amortization schedule works, you will be in control of paying your mortgage off faster. I will illustrate a few scenarios and change a few criterias so that you can see the flow on effect of how altering your payments can save you from higher interest charges.

Example:
A few assumptions: Interest rate is variable but will remain unchanged for 30 years for simplicity. I’ve rounded up or down to the nearest dollar. The average loan amount is $300k so I’ll use that for my calculations

Purchase price of house: $375k ($375,000)

20% deposit: $75k
80% mortgage loan amount also known as the principle: $300k
Variable interest rate: 8%
Loan period: 30 years = 360 months
Repayment: Principle + Interest loan
LVR: $300k/375k thus LVR is 80%

Monthly repayment is $2,201 composed of:
Principal: $201
Interest: $2,000

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Scenario 1)

You make the same $2,201 payment each month for the next 30 years. No extra repayments. As you can see, your very first mortgage payment, $2,000 goes into the bank’s pocket, and only a measly $201 is applied to reduce your principal loan (the $300,000), leaving you with a loan balance of $299,799

After each month’s payment, you are knocking a further pitiful $1 to $2 or so amount off the principal amount. After one year of paying your mortgage, you feel like you’ve gotten no-where.

You’re absolutely right, you’ve gotten no-where because across that first year, you’ve diligently paid $2,201 each month but out of that - you have paid the bank a whopping $23,909 interest and you’ve knocked only $2,506 off your principle. Leaving your loan balance at $297,494

This is the amortization chart for the first year of your mortgage with this scenario:

Year Month Repayment Interest PrincipalBalance
1 1 2,201.29 2,000.00 201.29 299,798.71
1 2 2,201.29 1,998.66 202.63 299,596.08
1 3 2,201.29 1,997.31 203.98 299,392.10
1 4 2,201.29 1,995.95 205.34 299,186.76
1 5 2,201.29 1,994.58 206.71 298,980.05
1 6 2,201.29 1,993.20 208.09 298,771.96
1 7 2,201.29 1,991.81 209.48 298,562.48
1 8 2,201.29 1,990.42 210.87 298,351.61
1 9 2,201.29 1,989.01 212.28 298,139.33
1 10 2,201.29 1,987.60 213.69 297,925.64
1 11 2,201.29 1,986.17 215.12 297,710.52
1 12 2,201.29 1,984.74 216.55 297,493.97
23,909.45 2506.03

Holy cr@p, you didn’t know you paid that much interest right? You may be one of the few that do know, but there are many people out there, clueless about this breakdown, paying their mortgage, month after month, year after year, and getting frustrated about why they haven’t managed to pay off anything.

Ten years later, you’re still doing the same old monthly payment, month in, month out, blissfully unaware that by the end of the tenth year, you have paid the bank, interest totaling $227,330! And how much principal have you knocked off the loan? Only $36,825! And what’s the balance of your loan to pay? $263,175

The ball is in your court when you reach the 22nd year of your mortgage, after 257 months worth of $2,201/month payments, your interest component is $1,098 and principal component $1,103, leaving your mortgage loan balance at $163,647

Now after 22 years it’s in your favour. It had taken you 22 years to pay off $136,353and the next 8 years to pay off $163,647 in principal.

Why did you suddenly pay off 55% of the loan in the last 8 years and it took you 22 years to pay off 45%?

It’s because the principal component finally exceeded the interest component of your monthly repayments. Finally after 30 years of $2201/month repayments later, you finally paid off your mortgage and you’ve also paid the bank $492,471 in total interest. A total balance of $792,471!

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Scenario 2)

Same amount borrowed (300k), same interest rate (8%) for the same period (30years)
Same repayment amount at $2,201/month

Except in this example, you earned a $2,000 bonus at work the second month into your mortgage and you decide to pay this lump sum into your mortgage to reduce the principal loan by $2000. I will now show you how much that $2000 saved you across the life of the loan.

•You will be mortgage free 9 months earlier
•You will end up paying a total interest of $473,360
•This saves you paying interest of $19,111 across the life of the loan…all this interest saved for just making a lump sum repayment into your mortgage at the beginning of the loan

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Scenario 3)

Same amount borrowed (300k), same interest rate (8%) for the same period (30years)
Same repayment amount at $2,201/month

Except in this example, you earned a $2,000 bonus at work at the end of the third year (36 months) into your mortgage and you decide to pay this lump sum into your mortgage to reduce the principal loan by $2000. I will now show you how much that $2000 saved you across the life of the loan. It will be less of a saving than scenario 2 because the earlier you make the extra repayments, the more interest you save:

•You will be mortgage free 7 months earlier
•You will end up paying a total interest of $477,522
•This saves you paying interest of $14,949 across the life of the loan…all this interest saved for just making a lump sum repayment into your mortgage at the end of the third year of your loan

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Scenario 4)

Same amount borrowed (300k), same interest rate (8%) for the same period (30years)
Same repayment amount at $2,201/month

Except in this example, you earned a $2,000 bonus at work the second month into your mortgage and you decide to pay this lump sum into your mortgage to reduce the principal loan by $2000. Not only that, you decide to give up buying coffee for three days of the week (latte effect) saving you $3 x 3 days x 4 weeks equals $36/month in savings. You can really sacrifice anything you like to come up with the savings. I’m just using a very simple, easy to achieve sacrifice as an example.

Your extra repayments are now $2000 in month two and $36/month until you pay the mortgage off:

•You will be mortgage free 2 years and 6 months earlier!!
•You will end up paying a total interest of $439,204
•This saves you paying interest of $53,267 across the life of the loan

All this interest saved for just making a lump sum repayment early on in our mortgage and the extra small amount of $36 that you were paying every month on top of your regular $2201/month payment.

It’s simple little things like what I’ve hypothesized for you above that makes a huge difference in how you can pay your mortgage off faster and how you can save thousands of dollars in interest. Making extra repayments means that you’ve utilized the power of compounding in your favour rather than letting the bank use compounding in their favour to charge you interest.

You can use mortgage calculators and amortization schedules to do your own scenarios. My intentions are just to demonstrate how a few simple extra payments and how you pay those payments against your home loan, can shorten your loan and also save you thousands of dollars in interest.