What does it mean to pre-pay on your mortgage? It all boils down to paying on your principle versus paying on your interest. Landmark Home Warranty walks you through the ins and outs of how you can pay on your mortgage to decrease the amount of money you owe. (You can save money by purchasing home warranties and save money on home repairs and replacements, too!)
What is Principle and Interest?
PITI is an acronym that many homeowners have probably heard. It’s short for Principal, Interest, Taxes and Insurance. PITI is everything that a homeowner pays for when they pay their monthly mortgage payment. (This does not include home insurance, home warranties or utilities.)
The principal of the payment is paying back the actual money that was borrowed. If you borrowed $300,000, when you pay your mortgage payment part of that money goes toward paying off the principal. The other part will be to pay off your interest.
Interest is how lenders make money. They lend you money with the stipulation that you pay it back with interest. This is a percentage of the value of the loan. When you pay your monthly payment, part of that is a percentage of interest on your loan. So, if you borrowed $300,000 at 4% APR (annual percentage rate) for 30 years, your monthly payment would include the monthly amount of $300,000 divvied up between 360 months, plus 4% of that $300,000 each year. Each month you would pay $1,512.
Every homeowner has to pay property taxes in their mortgage payment. This is dependent on where their home is and their property tax laws.
If a homeowner has marginally bad credit, or if they couldn’t afford to put a 20% down payment on a home, they usually have to pay mortgage insurance (This is not the same as home insurance or home warranties). This mortgage insurance is factored into the mortgage payment and is a percentage of the home’s value. It protects the lender if the borrower defaults on their loan.
How do I Pre-pay my Mortgage?
When you pre-pay on your mortgage you pay extra on your monthly payments. Since interest is an annual percentage, calculated based on how much principal you owe, adding extra money on your bill each month pays of your premium instead of your interest.
Think of it like this: you’re right at the start of that 30 year loan for $300,000. This year, you know you’ll pay $10,000 on your premium, and with your annual percentage rate, being 4% of what you owe ($300,000) you’ll pay $12,000 this year. By this time next year, you’ll owe $290,000 on your premium. Then, assuming you have a fixed rate mortgage, and your interest rate remains the same, 4% of $290,000 is $11,600 in interest. However, if you decide to pay more than the monthly payments, you’re not paying on your interest for the year, since that’s fixed at 4% annually. You’re paying on your principal. So, the more you pay on your principal, the less money you have to pay interest on in the long run.
If you want to pre-pay on your mortgage, make sure your mortgage payment allows for pre-payment. This isn’t a clause in most mortgages, but others fine you for pre-paying, so it’s a good idea to call and check. While you’re calling, ask what is best to pre-pay. Some lenders include a spot to add extra money, while others do it automatically. After, calculate how much money extra you can pay per month. Sometimes this is only a few dollars, but it can really add up over the months.
Should I Put Down a Larger Percentage for my Down Payment?
If you’re just starting out and you’re wondering if you should put a larger down payment on the home or just save the money for mortgage payments, remember this: The more money you put down initially, the less money in interest you have to pay. You should always have a few months of back-up mortgage payments just in case, as well as money to pay for home insurance, home warranties, utilities and upkeep of a home. This animated graph shows you what happens to the amount of interest you have to pay (the black bar) when you pay a bit extra on a down payment:
For more information on home warranties, go to www.landmarkhw.com. Landmark provides home warranties for homes and repairs or replaces failed systems and appliances. Home warranties are an excellent way to save money, especially when it comes to older homes.