Photo: View from our backyard, taken January 2016.
Over the past year, I have done a lot research and a lot of re-looking at our finances. By taking this time to look deeply at the financial world and our finances specifically, I have learned a lot and this has shaped my views on life and finances. Finances affects a large amount of your life, because it can stress people out if they are not in control of where their money goes. My research led me to realize the amount of money that can be saved by taking out a 15-year mortgage as opposed to a 30-year mortgage. Because of this research my wife and I took out a 15-year mortgage with the anticipation that we would try to pay it off early. So, just like everything on this blog, I like to use our finances as a case study for the whole world.
We took out a mortgage in August of 2015 and our first payment was due on October 1, 2015. Although, we have payed all of our mortgage payments around the 15th of the prior month, because that was when we would put money in our savings accounts prior to purchasing the house. This means in 2015, we payed 4 minimum mortgage payments and we also payed 4 extra principal payments. Over the 4 months, our total amount owed has decreased 2.4%. That doesn't sound like a lot, but that is the issue with taking out a loan. A good chunk of the payment goes towards interest. The current payment breakdown is shown below:
- Principal: 43.4%
- Interest: 30.1%
- Homeowner's Insurance: 4.3%
- Taxes: 22.2%
As you can see, less than 50% of our monthly mortgage payment goes towards paying off principal and 30% goes toward interest payment. A financial guru and former pastor, Chris Brown, has a great statement, "Interest paid is a penalty and interest received is a reward." The goal is to earn interest not continually pay interest. So, that is where the benefits of extra mortgage payments come into play.
Here is the breakdown of extra payments and how it affected the total interest paid.
You will notice that the total interest payment was going to be $67,019.89 over the course of 15 years, but we have shortened the loan length and decreased the total interest paid over the course of the loan. It has decreased by a total of $1,161.09 in four months. I calculated this number through an excel spreadsheet that simulates mortgage amortization schedules. I created an extra column each month for extra payments and those payments decrease the principal amount only. I then scroll down to the end of the document and it will tell me the total interest to be paid. I delete a row at the end, when the interest become negative. The extra payments have shortened our mortgage by 1 month. As we continue to make extra payments, then our loan length will continue to decrease.
Based on the information above, I found two major benefits that occur when you pay off a mortgage or any loan early. First, the mortgage will be paid off faster. This means that you will be out of debt sooner than expected and that mortgage payment now becomes a huge amount of money to use in investing. Secondly, the interest paid over the course of the entire loan will continue to decrease with each extra payment and you will be able to save this money in the long run.
I am going to end this article with a great quote from Dave Ramsey, "Remember that debt is dumb, cash is king and the paid off home mortgage has taken the place of the BMW as the status symbol of choice." Dave makes that statement daily on his radio show and he is a huge proponent of paying off the mortgage early, because it will give you a sense of peace and it gives you a huge amount of money to start throwing at investments. He says, "The grass feels different under your feet when you own it as opposed to the bank owning it." One thing that I must say is that you can't let the fact that you are trying to pay off the mortgage early stop your investing. You must invest and pay the mortgage at the same time, because you can't lose those years of compound interest. Yes, paying off the mortgage is smart, but its only smart if you invest as you pay off your mortgage.