Each month, like clockwork, your checking account balance is reduced by another of your mortgage’s monthly payments. If you are like most homeowners, you’ve wondered if it is possible to pay less interest, reduce your monthly expenses and pay off your mortgage faster?
Yes, there are techniques to reduce the interest you pay monthly if your cash flow allows you to pay extra monthly payments towards principal.
But first, it is important to explain the basics of your mortgage payment before you try to reduce your interest.
Your monthly mortgage obligation, which is often referred to as PITI — is composed of Principal, Interest, Taxes, and Insurance.
- Principal & Interest (P & I) — this is the portion of the monthly payment that is directly related to the mortgage balance and the rate of interest. These are the factors that influence how much interest you pay.
- The Principal Portion — the amount of your payment that is applied to the outstanding mortgage loan.
- The Interest Portion — the amount of your payment that is applied toward the interest, based on your outstanding balance and rate.
At the beginning of the mortgage, the P&I payment is mostly applied to interest due on the outstanding balance. However, as you progress through the mortgage term, the principal portion paid each month slowly increases — which means that the interest portion decreases — as the loan balance decreases.
The other components, which have no influence on interest, include–
- Real Estate Taxes (T) — depending on the location of the property, there may be a variety of property taxes associated with property ownership.
- Insurance (I) — this typically includes homeowner’s insurance (property, liability, etc.) but may also include (PMI), if applicable. Mortgage insurance is often required for FHA loans and conventional loans.
There are only two ways to reduce the amount of interest paid each month – you can lower the current rate or reduce the amount you owe by making an extra payment or two.
Pay less interest by reducing the mortgage interest rate.
Reducing the interest rate will result in a lower amount of interest due. Consider this mortgage scenario that clarifies how interest rate changes impact mortgage interest due. The 30-year mortgage rate for $240,000 is 5%.
Interest for a $240,000 mortgage at 5% would be calculated as follows:
- Yearly Interest = Mortgage * Interest Rate ($12,000 = $240,000 * 5%)
The monthly interest for the above example would be $12,000/12 or $1,000.
What happens to the monthly mortgage interest if my interest rate is reduced?
If the rate for the above-referenced mortgage were reduced to 4%, how much less would the interest payments be? Using the specs from the above analysis, the monthly interest on the mortgage would drop by $200 to $800 per month.
Here is the math:
- $240,000 * 4% = $9,600 yearly or $800 per month.
- This is equivalent to a savings of $200/month [$1,000 – $800].
Pay less interest by reducing the mortgage principal or outstanding balance.
Here is an example that clarifies the impact of reducing the mortgage principal.
Assume you have inherited $40,000 and would like to apply this amount to the balance of the mortgage noted above.
What happens to the monthly interest if the principal is reduced?
How would your monthly interest payment be impacted if the principal balance is reduced by the money you have inherited?
Remember – these are the mortgage terms from the example above:
- Yearly Interest = Mortgage Balance * Interest Rate ($12,000 = $240,000 * 5%)
- The monthly obligation for the above example would be $12,000/12 or $1,000
If you reduce the mortgage balance by $40,000 to a balance of $200,000 – the interest would calculate as follows:
- $10,000 = $200,000 * 5%
- The monthly interest with the reduced mortgage balance would be $10,000/12 or $833.33.
This is equivalent to a savings of – or a savings of $167/month [$1,000 – $833].
Other ways to reduce monthly mortgage payments
Reducing interest is one of several techniques that may allow you to pay less each month towards your housing obligation.
- Eliminate Private Mortgage Insurance (PMI) — PMI is a type of insurance that helps reduce the mortgage lender’s risk. PMI is required for mortgages when borrowers put down less than 20% of the purchase price. For those with monthly insurance premiums, getting rid of PMI on your mortgage or reducing your PMI of an FHA loan is likely the easiest way to reduce your monthly payments.
However, a borrower may request that their PMI payments be waived if the existing mortgage and property value meet specific criteria. PMI, which began at mortgage origination/closing, can often be eliminated if the principal is reduced or the property appreciates.
- Reduce Your Property Taxes – Property taxes are calculated by multiplying the jurisdiction’s tax rate by the most recent value of the property (its assessed value). An assessed value is a value as viewed through the eyes of an authorized property valuation professional. Knowing how much your home is worth is the first step in reducing your property taxes.
How to reduce interest payments on your mortgage?
There are two factors that impact the mortgage interest due each month.
These include the mortgage balance or current rate. Lowering one (or both) can lower the interest payment on your mortgage. The sooner you begin, the larger the savings over the life of the loan.
Lowering your interest rate to one of the more competitive mortgage rates can be accomplished by refinancing or remortgaging your current loan. Some mortgage lenders may offer, through the payment and processing of mortgage recasting fees, another option to reduce the mortgage rate.
When refinancing, a borrower has the option to revise or modify their current mortgage balance. They can a) reduce the mortgage balance, b) keep the same balance or c) use the refinance to take more money and maybe some extra cash to create an emergency fund or pay down student loan debt.
Does paying off principal reduce monthly payments?
The answer to this question is two-pronged because the correct answer depends on whether you have a fixed-rate or an adjustable-rate mortgage.
For Fixed Rate Mortgages
If you send extra money to reduce the balance on a fixed-rate home loan, this will reduce the term and help you save money. In other words, paying off your mortgage early will not reduce the current fixed payment.
For Adjustable-Rate Mortgages
If you are sending extra money to reduce the balance on an Adjustable-Rate Mortgage (ARM) home loan, the extra payments will adjust when the mortgage interest rate adjusts.
Is it better to overpay the mortgage monthly or make a lump sum payment?
Each of these techniques will help reduce the interest paid on your mortgage each month. However, before proactively paying down your mortgage, confirm there is no penalty to prepay the mortgage. Although not common, some mortgages include prepayment penalties.
Do you pay less interest if you pay your mortgage twice a month?
Yes, ultimately, paying half of your current monthly principal and interest payment (P & I) every two weeks will help a) reduce the interest paid and b) the time (or loan term) it takes to pay off the loan.
This payment schedule is known in the trade as a bi-weekly payment option. The reason you pay a reduced amount of interest when making biweekly mortgage payments is simply related to an imperfect calendar, which creates an extra monthly mortgage payment each year.
This strategy essentially forces the borrower to make an extra mortgage payment each year – 13, not 12. These extra mortgage payments, over time, save several years and tens of thousands of dollars, depending on the loan size – leaving you debt-free sooner.
The following examples clarify the concept of bi-weekly payments. Note, it is important to confirm that your mortgage lender accepts biweekly payments if you wish to pay off your mortgage with an extra mortgage payment.
For both scenarios, note that you currently have a $275,000 mortgage on your home with a fixed interest rate of 4.5%. Your monthly principal and interest payment for this fixed-rate mortgage is $1,393.38 per month.
Scenario #1 – Pay the mortgage over the 30-year term, with twelve payments each year.
This requires a total interest payment of $226,616.80 over the life of the loan. This is calculated as follows –
- Total payments – $1,393.38 12 30 (years) = $501,616.80.
- Interest Paid equals total payments minus original principal balance or $501,616.80 – $275,000 = $226,616.80
Scenario #2 – Pay half ($696.69) of your current monthly payment twice per month method or extra monthly mortgage payment each year.
A bi-weekly mortgage in this scenario would save 53 payments. The original 30-year term would be reduced to 25 years and four months. These additional principal payments (essentially one extra mortgage payment yearly) reduce the total interest paid for the bi-weekly mortgage to $187,663.45.
The above analysis reveals an interest savings of $38,955.01. This is the difference between the interest paid for the 30 years -$226,628.46, and the interest due when paying bi-weekly – $187,663.45.
What happens when I pay an extra $100 per month on my mortgage?
Payments of $100 to your current mortgage payment are the simplest (and most cost-effective) way to reduce your mortgage balance. And in reducing the outstanding loan balance, the amount of interest you pay will be less. To boot, you will pay off the loan early, faster than its original loan term.
Borrowers pay smaller lump sum payments (like rounding up to the nearest $50) to reduce the outstanding mortgage balance. This, too, helps because, over time, the interest due on the mortgage is reduced, although at a slower rate.
The amount you can save will vary and be based on the amount and frequency of your extra payments as well as the existing loan balance.
Why you shouldn’t pay off your house early?
There are several reasons NOT to pay off your mortgage on your house early and to consider putting money to other more beneficial financial objectives.
The money you would use to pay off your mortgage could be used to pay down debt with higher interest rates, like credit card debt. In addition, mortgage interest offers borrowers tax benefits that make include a tax refund or incentive.
Lastly, many financial experts and advisors would argue that paying off your mortgage early is not the best use of your capital. Instead, they’d recommend you use that extra cash to make investments in higher-yielding investments, like stocks or other annuities.
How can I pay less interest on my mortgage each month?
Paying reduced interest on your mortgage each month can be done by reducing —
- Your outstanding mortgage balance
- The interest rate
Regular, biweekly payments or extra payments used to reduce a loan balance on a fixed rate will help you pay off the mortgage loan faster. The accelerated mortgage payments decrease the loan term, which is where you truly save money.
Remember to save money by paying off your mortgage faster; time is on your side. The sooner a borrower can begin to make an extra monthly payment and reduce their mortgage balance (or improve current interest rates), the greater the impact on the total interest paid.
Pay less interest on your mortgage is easier than you thought!
Now that you’ve read about all the different ways to pay less mortgage interest, you hopefully feel prepared to implement some of the solutions. If you’re still confused or have questions, please reach out to your mortgage advisor or message us on social media!