Please note that I have not converted currency to dollars in this post as I didn’t deem it necessary, given that the fundamental concepts still apply.
Today’s topic for discussion is Amortization – in the Mortgage sense of the word. In Mortgage terms, it is essentially a fancy term that people use to discuss how much equity you -Vs- how much you owe over time.
While your mortgage is worked out over a fixed period of time and is calculated to have equal monthly installments; these will equate to less interest and more equity every month. Let me explain….
If I owe 100,000 and pay 5% interest a year, this equates to 5000 interest on the total amount. This is worked out at a monthly rate – i.e. 5%/12. However, because I am making repayments of 2000 a month, this is partly repaying equity, hence the next month I will no longer owe 100,000 and wouldn’t have to pay as much interest – hence although my repayment stays the same, a larger portion is paying of equity.
A lot of people can’t get their head around this, but it seems so simple when you do! After gaining a proper understanding of this concept, the significance of over-payments on your mortgage becomes apparent. Without explaining any further, consider the table at the end of the post. This refers to the mortgage that we have recently taken out.
Note I have simplified my spreadsheet to highlight the important parts. If there is interest I will upload the full document.
The ‘Standard Equity’ column details the amount we own of the house worked out on a 25 year loan period (interest rate 4.19%), while the ‘New Equity’ details the amount we own with over-payments. I have calculated this based on an overpayment of £400 each month. This is roughly £100 per week – not a hugely significant amount on a weekly basis.
This is where it gets very interesting – by increasing our monthly payments by £400, we knock 10 YEARS off the duration of the mortgage!! Wow! Not only that, but we save a little under 50K in interest charges!
Even if you couldn’t afford to reduce your mortgage by 400 a month, an increase in only 50 per month would knock 2 years off and save over 10K!!!
Check out the Calculator Here – This will work for any currency.
Two more incentives for paying off our mortgage early:
- Interest Rates are very likely to increase. Our mortgage is fixed at 4.19% for 2 years – The sooner we can pay it off the better!
- The breakdown will encourage us to continue to make over-payments with any extra money that we make. I will commit right now that if I ever make money from this blog that 90% will go to over-payments!
- The more equity we can get in the house, the sooner we can buy a second property for letting purposes
- The potential not to owe any money to anyone long before we hit 40. This gets us one step closer to starting our dive school! 🙂
Homeowners – work out how much you could save, commit to an amount and JUST DO IT!
Question Time: Does anyone make regular over-payments? How long have you been doing this for and how much have you saved?
Modest Money says
Good luck with paying off the mortgage early. It is a lot more motivating to pay off your mortgage earlier when you crunch the numbers like that. $50k and 10 years is nothing to scoff at. This is why it is important that people do not commit to a mortgage that has penalties if you pay it off early. Hopefully by running your blog you find more ways to save money and put more towards your mortgage each month.
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Kris @ BalancingMoneyandLife says
It’s amazing how much you can save with even small extra payments! I get paid every 2 weeks, so 26 times per year. By setting our mortgage to be paid 26 times a year instead of 12 or 24, I shaved 5.5 years off our total repayment time. It was a no-brainer for me!
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Financial Advice for Young Professionals says
Good Post! A lot of people forget that when they refinance their amortization clock also starts over! You have to increase the payment to make the savings worthwhile if you intend to pay off the whole loan.
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Thanks! Yes I know – banks are great at resetting a default term to 25 years. A lot of people don’t even realise the difference the small extra repayments can make! What is your current situation? Thanks for commenting 🙂