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Can I pay $12,000 extra once a year or $1000 every month - which option is better? The first option does sound better, but for a 30 year mortgage, is it that significant? The mortgage is for $527,000 @4.375 fixed rate with no penalty for pre-payments. How much money and years on a mortgage can I save? When is the best time to pay? At the end of each year?

user56396
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Barb
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5 Answers5

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Can I pay $12,000 extra once a year or $1000 every month - which option is better?

Depends when. If you mean 12K now vs 1K a month over the next 12 months, repeating this each year, now wins. If you mean saving 1K a month for 12 months then doing a lumpsum, the 1K a month wins. Basically, a sooner payment saves you more money than a later payment.

The first option does sound better, but for a 30 year mortgage, is it that significant?

Your number one issue is that you have a thirty year mortgage. The interest you pay on it is monstrous. For the 30 year term, you pay around 500K in interest. A 15-year mortgage is 300K cheaper (only 200K in interest will be paid). The monthly payment would be 1250 more.

How much money and years on a mortgage can I save? When is the best time to pay? At the end of each year?

You can knock off about a dozen years. Save I think ~250K. You can find mortgage calculators online or talk to your mortgage advisor to play around with the numbers.

Lan
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    If OP invested the 1K/month in equities earning 6% in average annualized returns over thirty years, they'd have 1000000. So, the extra 1K/month payment is a "guaranteed" 250K savings whereas conservatively investing may net a million. The choice is up to OP but I realized it is irresponsible of myself to not mention this. – Lan May 09 '17 at 12:45
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    I challenge the assertion that 6% is a "conservative" investment. By writing "For the 30 year term, you pay around 500K in interest" you imply that OP will pay $500K interest. But it's only true if OP pays the minimum every month. – RonJohn May 09 '17 at 13:12
  • @RonJohn The long run average for the S&P 500 is 11%. 6% is conservative. (I am using non-inflation adjusted returns since the mortgage itself is not inflation adjusted.) You are correct about the 500K interest comment. I am comparing minimal payments to 12K/year more which is not appropriate if OP is already paying above the minimal payment. – Lan May 09 '17 at 13:26
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    @lan no it's not. currently S&P500 is at 2400. 30 years ago it was at 650. Which means it's now 3.68 times it was. This translates in an average of about 4.3%. – Pieter B May 09 '17 at 14:59
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    @PieterB That is inflation-adjusted and is not including the dividends. If you don't adjust for inflation, it went from 290 to 2400. Which is 7.3. If you adjust for reinvesting the dividends, it was 9.6%. – Lan May 09 '17 at 15:41
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    The "invest vs pay off mortgage" question is an interesting one but not part of this question given it's well covered elsewhere. – Joe May 09 '17 at 21:12
  • Interesting to simultanesously say, "The interest you pay on it is monstrous" and also, "it's irresponsible not to suggest borrowing money at that rate to invest in an index tracker" ;-) Not saying you're necessarily wrong to say either thing, just that it's interesting how different approaches lead to different adjectives. – Steve Jessop May 10 '17 at 00:21
  • What I meant to say Steve is that I can't in good faith mention how much one "saves" in interest by paying early without acknowledging that in economics one evaluates their next best alternative. Including risk. – Lan May 10 '17 at 20:58
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"When is the best time to pay? At the end of each year?"

If you save $1,000 each month at 1% so as to pay $12,000 at EOY on a 4.75% loan, you've lost "4.75% - 1% = 3.75%" over that year. (And that's presuming you put the money in a "high yield" online savings account.)

Thus, the best time to pay is as soon as you have the money.

EDIT: This all assumes that you have an emergency fund (more than the bare minimum $1K), zero other debt with a higher rate than 4.75% and that you are getting the full company match from 401(k).

RonJohn
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Paying $12,000 in lump sumps annually will mean a difference of about $250 in interest vs. paying $1,000 monthly. If front-load the big payment, that saves ~$250 over paying monthly over the year. If you planned to save that money each month and pay it at the end, then it would cost you ~$250 more in mortgage interest. So that's how much money you would have to make with that saved money to offset the cost. Over the life of the loan the choice between the two equates to less than $5,000.

If you pay monthly it's easy to calculate that an extra $1,000/month would reduce the loan to 17 years, 3 months. That would give you a savings of ~$400,000 at the cost of paying $207,000 extra during those 17 years. Many people would suggest that you invest the money instead because the annual growth rates of the stock market are well in excess of your 4.375% mortgage. What you decide is up to you and how conservative your investing strategy is.

NL - Apologize to Monica
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If you're truly ready to pay an extra $1000 every month, and are confident you'll likely always be able to, you should refinance to a 15 year mortgage.

15 year mortgages are typically sold at around a half a point lower interest rates, meaning that instead of your 4.375% APR, you'll get something like 3.875% APR. That's a lot of money over the course of the mortgage. You'll end up paying around a thousand a month more - so, exactly what you're thinking of doing - and not only save money from that earlier payment, but also have a lower interest rate. That 0.5% means something like $25k less over the life of the mortgage. It's also the difference in about $130 or so a month in your required payment.

Now of course you'll be locked into making that larger payment - so the difference between what you're suggesting and this is that you're paying an extra $25k in exchange for the ability to pay it off more slowly (in which case you'd also pay more interest, obviously, but in the best case scenario). In the 15 year scenario you must make those ~$4000 payments. In the 30 year scenario you can pay ~$2900 for a while if you lose your job or want to go on vacation or ... whatever.

Of course, the reverse is also true: you'll have to make the payments, so you will. Many people find enforced savings to be a good strategy (myself among them); I have a 15 year mortgage and am happy that I have to make the higher payment, because it means I can't spend that extra money frivolously.

So what I'd do if I were you is shop around for a 15 year refi. It'll cost a few grand, so don't take one unless you can save at least half a point, but if you can, do.

Joe
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How much can I save?

Depends on inflation and what other investment opportunities you have. It could end up costing you millions.

Can I pay $12,000 extra once a year or $1000 every month - which option is better?

It depends on how risk adverse you are.

The first option does sound better, but for a 30 year mortgage, is it that significant?

How much of your time is it going to cost you to do it every month? What is keeping you from doing it every day? How much is your time worth to you. Giving the bank its money sooner is always better than giving it it's money from a saving interest perspective.

When is the best time to pay?

See above.

Sam
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