This calculator will show you how much you will save if you pay 1/2 of your mortgage payment every two weeks instead of making a full mortgage payment once a month. In effect, you will be making one extra mortgage payment per year -- without hardly noticing the additional cash outflow. But, as you're about to discover, you will certainly notice the "increased" cash flow that will occur when you pay your mortgage off way ahead of schedule! Below the bi-weekly payment results are two additional sets of results for how much faster the loan will be paid off by adding an extra $25 or $50 to each payment.
Instructions: Complete the top 5 entry fields and click the "Compute" button. If you are entering data for a future mortgage, you can leave the "Current monthly mortgage payment" field blank, and the calculator will compute the payment for you.
Getting Ahead With Extra Payments
Extra payments on your mortgage can help you gain control over your finances, save money and give you peace of mind. This is a great way to reduce the long-term cost of your mortgage. When homeowners calculate how much they will pay over the life of their housing loan, they will find that they may be paying two to three times the cost of the original property.
While your home is a necessity for shelter, there is no reason why you can't save money on your mortgage. There is a multiplier effect where $100 in extra payments will lead to more than $100 in savings on your mortgage. Couldn't you make a couple of extra payments each year over the life of a 30-year mortgage? Here is a description of what a mortgage is, history of the market and reasons why it pays to make extra payments on your mortgage [a glossary of terms is listed at the end of this article.]
Most people do not have a lot of money in cash or savings to purchase an expensive piece of land. A mortgage (also called a "deed of trust") is a way for people to live on a property while paying off the loan received from a bank or financial institution. Every nation has its own special characteristics for the mortgage.
The origin of the word "mortgage" is French meaning "dead pledge." This "dead pledge" is used to "encumber" real property - immovable land, dirt and soil. The mortgage is both a promissory note and security instrument. The promissory note is from the mortgagor (homeowner) to the mortgagee (the bank) promising repayment of the loan detailing the principal, interest rate and term.
With a traditional loan, the debtor is required to repay it no matter what happens. English Jurist Sir Edward Coke noted that if the property is foreclosed upon with a mortgage - the pledge is dead. If the mortgage is paid off - the pledge is dead. The property is the pledge (or collateral). Banks know that a fixed piece of land is the most secure form of a financial asset.
The mortgage is actually made from the debtor to the creditor. The bank gives the loan to the debtor for purchasing the property, the debtor gives the mortgage to the lender to pay for the loan. The debtor gets rights to the property as long as monthly payments are made.
Fixed versus Adjustable Rates
A fixed-rate mortgage (FRM) has the same interest rate over the life of the mortgage. An adjustable-rate mortgage (ARM) has a rate fluctuating due to some benchmark rate. Having an FRM is easier for budgeting purposes.
So why would anyone want an adjustable-rate mortgage? There are three primary advantages to an ARM: 1) it may allow people with bad credit to qualify, 2) some of these loans have an FRM for the first couple of years resetting to an ARM thereafter and 3) if interest rates go down, then an ARM might be more affordable.
The danger of an ARM is the human nature of consumption. Most people will tend to maximize their consumption and have very little in savings. When an adjustable-rate mortgage increases, most people are not able to make their monthly payments and default.
History of Mortgages
Every nation has different guidelines and laws governing mortgages based on culture and history. The United States has had a very robust banking system providing capital to its citizens. According to "http://www.randomhistory.com/1-50/037mortgage.html", mortgages in the 1700s and 1800s were only six years comprising 40 percent of the property value. American homeowners "typically renegotiated their loans every year."
The mortgages of the 1900s had "variable interest rates, high down payments, and short maturities." Before the 1930s, most people did not have high levels of debt - they owned few valuable assets and did not have access to loans. The mortgage debt related to total income was about 20% and the percentage of household assets represented by a home was about 15%.
More Capital for Home Loans
During the Great Depression, the American government realized that it needed to intervene in the economy to a large extent to keep it running. The United States government used five primary ways to influence mortgages: 1) regulations, 2) monetary policy, 3) insurance to protect against bank defaults, 4) pseudo-government agencies and 5) government departments. These actions helped the American mortgage market to develop.
In 1936, the Federal Housing Administration (FHA) was started according to "http://en.wikipedia.org/wiki/Mortgage_loan". The Federal National Mortgage Association (Fannie Mae) was started in 1938. After World War II, the G.I. Bill created the Veterans Administration (VA) leading to higher loan-to-value ratios up to 95 percent and terms extended to 30 years. Mortgage debt compared to total income increased to 73% during this time. The percentage of total assets comprised of a home increased to 41%.
The Government National Mortgage Association (Ginnie Mae) created uniformity in the mortgage market. The 1980s saw the adjustable-rate mortgage gain prominence as a way to price risk to those in the sub-prime market. The LTV ratio increased - if a homeowner borrowed $175,000 for a house worth $200,000, then the LTV ratio was 150,000 divided by 200,000 or 75%.
In the 1990s, the United States used its Freddie Mac and Fannie Mae pseudo-government institutions to make it easier for poor people to get a mortgage. Many of these poor people had not been able to qualify previously because they had bad credit, unsteady employment or low income. The goal was to increase home-ownership rates.
Banks also started to bundle mortgages into "mortgage-backed securities" (MBS) for resale to investors. This created a secondary market for mortgages. Many times, your mortgage will be "owned" by a financial entity or individual different from the original bank.
Natural Housing Development
The natural economic progression of housing starts with cities anticipating the growth of their communities by granting permits to developers. The government will provide sewer and water lines and roads for these housing developments. A town may have plenty of apartments available, but sees strong demand for homes. As income rises, people can move into more expensive houses.
After World War II, returning soldiers could get a decent job with no education. When they get married, they wanted to move their family into a nice home with a two-car garage. Rising incomes are essential to a healthy housing market. But as the supply of houses increased, the price of the existing housing stock would decline.
Housing Market is Based on Supply and Demand
The housing market matches the supply and demand of houses with those of people who need a place to stay. There are many factors involved, including income growth, neighborhood development, family structure and access to capital. These are all important factors in determining the characteristics of your mortgage.
For most individuals, the home is the largest purchase they will make. It satisfies the essential need for a roof over your head. Most people don't spend a lot of time calculating the cost of the mortgage in the long run. If they did, they would understand the benefits of extra payments.
When you apply for a loan, the bank will collect information on your job income, length of time at the job and financial assets. It will use this data and your credit score to determine your "creditworthiness." Your "creditworthiness" determines the odds of you repaying your loan.
If you have more money for a down payment, then this will lower your interest rate. Many lenders use a Loan-to-Value (LTV) ratio of 80% as the standard. Above that, the lender may charge a higher interest rate due to the increased risk for default.
Rising House Prices Encourage Speculation
Governments, banks and homeowners all benefit from rising house prices. Most localities depend upon real estate prices to raise property tax revenue. There is an in-built self-interest to see higher home appraisal. In the end, supply and demand will determine the price for a home.
As the American government helped strengthen the banking system, there was more access to capital. This fueled speculation by some who thought they could buy a house and "flip it" in five years to make a profit. This led to higher prices. In 2008, the sub-prime mortgage crisis destroyed this speculative bubble.
In the United States, any individual can look up any address on web sites, like "Zillow.com". This freedom of information has created a very robust housing market.
Other countries do not permit housing prices to be freely advertized. In many African nations, it is difficult simply to get a map, let alone real estate valuations. This has created a more restricted housing market.
Why Does it Take So Long to Pay Off Mortgages?
If you do the math, then paying $1,000 every month on a home worth $200,000 should have it paid off within less than 20 years. But most mortgages are 30 years, aren't they? Why does it take so long to pay off these mortgages?
Most mortgages front-load charges and interest at the beginning of the payment schedule. You aren't paying off much of the principal. Your first monthly payments might have 80% going towards interest and fees with only 20% allotted to paying off the principal. It is like boxing with shadows.
Compound Interest Adds up Quickly
Many housing experts estimate that most homeowners will spend two to three times the value of their house when they complete a traditional 30-year mortgage. One reason why it takes so long to pay off a mortgage is because of compound interest. Compound interest it like a treadmill - it is very difficult to keep up.
Banks are in the business of making money. They have deposits and turn these into revenue-generating loans with mortgages. While you receive the property, many banks are receiving 10 extra years of you paying off a loan or 33 percent of the mortgage time period.
Consider "P" as representing the principle and "I" as representing the interest on your mortgage. The first month, you pay P + I. But every month, interest is being added to your balance. Thus, the second month, you owe P + I + I. This is how compound interest works. The longer it takes you to repay your mortgage, the more interest will accrue.
Can You Afford Your Loan?
Due to more capital available, governments and banks offered more loans to people who could not afford them. The extreme was the NINJA loan, which stands for "No Income, No Job." Because of their surplus capital, banks actually made loans to debtors who had no real way or repaying their loans.
Banks have traditionally had very strict guidelines for who would qualify for mortgages. With the sub-prime mortgage crisis, financial institutions lowered these standards to make home loan available to more borrowers. Unfortunately, some debtors could not keep up with their monthly mortgage payments.
The term, "sub-prime" was a designation for a high risk debtor. The financial institutions are uncertain if they will get their money back from customers in this category. The reasons for this wariness is based on simple math, actuarial data and number-crunching. Most bankers estimate that 40% of monthly income should go towards mortgage payments. A debtor cannot afford his loan if it absorbs too much of his income.
In some Scandinavian countries, a mortgage does not have a set term. This has been discussed on the site - "http://www.fi.se" - in its review of the Swedish Mortgage Market for 2013. "In the sample of new loans only four out of ten households with a loan-to-value ratio of less than 75 per cent amortize. In addition, the average actual repayment period for first mortgages that are being amortized is very long (more than 140 years)." The longest that most humans live is for 120 years.
If a mortgage is going for 140 years and humans live to be 120, then obviously the mortgage is not expected to be paid off. Then, it is not really a mortgage is it? It is more like renting. If parents had repaid their entire mortgage, then they could sell the property, which would net them more money in the long run.
Your Mortgage is a Banking Cash Cow
So why are banks making mortgages that are impossible to pay off? It is because mortgages make these financial institutions a lot of money. Each monthly payment is revenue for a bank. If they could, they would have you indebted forever.
The concept of "amortization" is simply the gradual repayment of your mortgage. In order for a mortgage to be amortized, the monthly payments must be high enough to reduce the overall principal within the allotted time of the agreement.
Some banks will go so far as charging "prepayment penalties" to keep you enslaved to debt. These are fees for making "extra payments" on your mortgage. Carefully read your mortgage to see if these apply. It does not mean you "cannot" make extra payments, it only means that you will be "financially penalized" for doing so. If you do the math, sometimes extra payments with prepayment penalties will still save you money in the long run.
Housing is Expensive
If you make a down payment of 20% for a home, then you have the principal of the loan to repay, add closing costs, insurance and property taxes. Add in furniture, cleaning, painting, heating air-conditioning ventilation (HVAC) and woodwork. Once you pay off your mortgage, you will have more money for important repairs. You can also deduct mortgage interest, home-equity debt, vacation homes and mortgage points on your taxes.
Why Are Extra Mortgage Payments So Valuable?
During times of economic troubles, it makes sense to make sure your financial ship is in order. If you need extra money for an emergency, then having an unwieldy mortgage payment only gets in the way. In 2013, interest rates are at record lows in many parts of the world. But it cannot stay this way forever. Wise consumers are considering ways to gain control, save money and plan for the future by making extra payments on their mortgage today.
Extra mortgage payments are so valuable because they reduce the principal and interest. A lower principal will mean that the next interest rate charged will be added to a lower base figure. In the extreme, an extra payment could be the difference between foreclosure and paying off your mortgage.
Control Your Mortgage or Be Controlled by It
Banks are in the business of receiving payments for loans. They set up mortgages that are extremely beneficial to their bottom line. By making extra payments, you gain control of your mortgage repayment schedule, so you can handle unforeseen circumstances.
If you receive a large sum of money, why not make an extra payment on your mortgage? It will save you a lot of money in the long run. You can consider it a retirement investment. By gaining control of your mortgage, you increase your chances of being able to complete the repayment schedule.
Emergencies or Job Loss
All lives are fraught with unforeseen dangers. What are the chances that you will never experience any catastrophe or job loss during the 30 years of your mortgage? If you make extra payments on your mortgage, you could be better situated financially to handle these challenges.
You must remember that your mortgage is based on your original income. If you lose your job, then it will be very difficult to make your present monthly payments unless you have numerous savings and assets built up. With extra payments, you can be proactive and improve your debt situation before any catastrophe occurs.
By reducing your mortgage, you will have more money for other purposes. The secret to paying of a mortgage is paying off the principal first. Extra mortgage payments have a multiplier effect. If you pay off $100 early, it could save you more than $100 in mortgage payments due to the effects of compound interest. Just imagine what you could do with that extra money the first month after your mortgage is paid off.
Peace of Mind
With your mortgage paid off, you have more money to be spend on other elements of your life. You can consider selling your home and moving to a bigger or smaller home as you near retirement. You will sleep better with this debt repaid.
Improve Your Net Worth
Your mortgage is a liability – a continual drain every month. Paying off your mortgage is a way to increase your net worth. Extra payments have a double effect by increasing your equity (assets) and reducing your mortgage balance (liabilities.) You are vastly improving your financial well-being.
Glossary of Mortgage Terms
Here is a glossary of common mortgage terms:
- 100% Loan has no down payment.
- Adjustable-Rate Mortgage (ARM) (also called "floating" or "variable" mortgage) has fluctuating interest rate a couple percentage points above a benchmark rate.
- Amortization is the process of paying off the loan gradually with monthly payments.
- Annual Percentage Rate (APR) is how much interest is charged each year.
- Balloon Loan has one large payment occur during the life of the loan.
- Bridge Loan offers financing between sale of first home and purchase of second home.
- Conforming Loan satisfies government standards for acceptable risk.
- Credit Score is a number to measure a debtor's creditworthiness.
- Deed of Trust is a mortgage form with third-party trustee.
- Department of Veterans Affairs (VA) offers low-interest loans.
- Equity is the market value of your home minus what you owe.
- Federal Deposit Insurance Corporation (FDIC) guarantees bank accounts up to a certain limit.
- Federal Home Loan Mortgage Corporation (Freddie Mac) is a government-sponsored mortgage program.
- Federal National Mortgage Association (Fannie Mae)is a government-sponsored mortgage program.
- Fixed-Rate Mortgage (FRM) has set interest rate.
- Foreclosure is the legal process of the lender repossessing or seizing the property.
- Graduated-Payment Mortgage (GPM) is fixed-rate mortgage gradually increasing. This is best for the young who expect to receive increasing income over their lives.
- Home Equity Line of Credit (HELOC) is a loan a homeowner can make once he has built up equity in his property.
- House-Poor is a description of someone with a home who does not have much money left after making mortgage payments.
- Hybrid = Combination of ARM and FRM.
- Interest is the price of the loan.
- Jumbo Loan (also called "nonconforming" loan) does not meet federal loan guidelines.
- Loan-to-Value (LTV) ratio = Most property is purchased with a down payment and mortgage. If the down payment is 20%, then the LTV is 80%.
- Mortgage Insurance pays balance if debtor defaults.
- Mortgage-Backed Securities (MBS) are bundles of mortgages resold by financial institutions to investors.
- Negative Amortization Loans have artificially low monthly payments making it impossible for the homeowner to pay them off in a reasonable period of time.
- No Income, No Job (NINJA) Loan where homeowner has no income or job.
- Option Adjustable Rate Mortgages (also known as payment option ARMs) have wide variety of lending terms.
- Piggybacking is creating a first loan below the jumbo limit and a second home-equity loan to pay for the rest of the mortgage.
- Prepayment penalties charge you fees for making extra payments on your mortgage.
- Principal is the original balance of the loan.
- Principal, interest, taxes and insurance (PITI) are the most common parts of a mortgage.
- Private Mortgage Insurance (PMI) covers costs of foreclosure if debtor defaults.
- Redemption is paying off the final balance of the mortgage.
- Reverse Mortgage is similar to an annuity paying senior citizens a steady stream of income for their home equity.
- Servicing a Loan is the procedure of collecting home payments.
- Short sale involves a homeowner in default to sell the property for less than it is worth to avoid foreclosure fees.
- Term is how long the mortgage runs (usually 15 or 30 years.)
- Underwater is when the principal on your mortgage is worth more than your home is worth due to falling prices.
Key Tips & Advice
Things to consider when buying a home:
- While the 30-year mortgage is the most popular term in the United States, a 15-year term builds equity much quicker;
- Home buyers in the US move on average of once every 5 to 7 years;
- Early mortgage payments apply primarily to interest rather than the principal;
- Using a shorter loan term, paying extra & making bi-weekly payments can better help offset any transaction-based expenses.
Do Home Prices Always Go Up?
In the United States real estate prices have went up about 6-fold since 1970.
Our monetary policy is biased toward inflation. If you back out general inflation, outside of during market bubbles, real estate typically performs roughly inline with general inflation. Rather than looking at raw prices, better metrics to use for analyzing real estate prices are:
- Home price vs median income.
- Purchase price vs rent.