Should I pay off my mortgage early? And if so, what’s the best way to do so?
These are questions that many homeowners wonder about, and ones you may have heard from your clients through the years. My guess is many homeowners do not fully grasp how amortization works. Let’s review the essentials of amortization and why it might be of benefit for your clients to pay an additional amount toward their mortgage each month.
What is Amortization?
Amortization is the process of reducing or paying off debt with regular payments. In order for your clients to fully understand amortization, we must break down the parts of a mortgage payment for them.
The majority of mortgages today are fixed payments and part of that monthly payment is broken into two parts – principal and interest. The amount of interest is calculated from the interest rate and remaining loan balance. So, as the loan is paid off, the amount of interest paid decreases over time.
The principal portion is the amount that remains after the interest has been deducted. Unlike the interest portion, as your clients pay off their loan, the amount going toward principal increases over time.
Consider this example you could share with your clients. Let's say they have a mortgage of $100,000 at 5% for 30 years. Their fixed payment, or the amount they would pay every month, would be roughly $537.
To calculate the interest portion in a month, we multiply the balance of $100,000 times the annual interest rate of 0.05 and divide by 12 months in a year to get $416.66.
Meanwhile, the principal payment for the first month is what remains after the interest portion is deducted. In this example, we subtract the interest portion of $416.66 from the total payment amount of $537, which gives us $120.34 paid toward the principal. Using this amount, the loan balance is reduced from $100,000 to $99,879.66.
The following month, the new loan balance is used to calculate the interest portion of the payment. Since a smaller amount of money is owed to the lender, the interest charge for the month is $0.50 lower at $416.16. That makes the principal payment in month two $0.50 higher at $120.84.
This process repeats each month with the interest portion of the monthly payment gradually declining and the principal portion gradually rising. Every month that goes by, your clients pay less interest because their loan balance is lower.
The Power of Amortization
One simple way for your clients to accelerate the payoff process of their loan is to pay an additional amount each month because 100 percent of these extra payments are applied toward the principal balance on their loan.
Surprisingly, even small extra payments can have a large effect on your clients’ finances over time. If the payment in my previous example was increased by just $200 a month, your clients would pay off their loan 13 years sooner! This would mean your clients would make 159 fewer mortgage payments in total.
360 payments: $537/month
Total Paid: $193,256
Total interest: $93,256
Paying $200/Month Extra:
201 payments: $737/month
Total Paid: $147,708
Total interest: $47,708
This example is a great way you can show your clients how they can reduce their overall interest expense. Your clients can consider these extra payments as investments that earn them a guaranteed return equal to their loan's interest rate. And in rough times like today, with recession talk on the horizon and the stock market having seen better days, this rate of return might outperform alternative investments. This is just one example of why it might be a good idea for your clients to pay off their mortgage early.
But what if your clients can’t afford to pay an extra $200 a month toward their mortgage?
During times of economic uncertainty and high inflation, it might not be possible to put a set amount of extra money towards a mortgage payment each month. But occasional lump sum payments can also be a great way to achieve similar results.
Let’s say that after 11 months of regular payments, your clients have an extra $2,000 that they could put towards their mortgage payment.
This one-time extra payment would shorten their loan term by 15 months, equaling $8,055 in payments. What is magical about this is the compounding effect. Each time your clients make a payment they are going to keep more of their money and spend less in interest.
Amortization is a great way to educate your clients about how to create wealth, meet their retirement needs or achieve their goal of owning their home free and clear – and the tools available in MBS Highway can easily help you illustrate this. Take a free 14-day trial of MBS Highway and learn more about how our Bid Over Asking Price, Buy vs. Rent Comparison, Loan Comparison tool, daily coaching videos, lock alerts and more can help you better serve your clients and grow your business now and for years to come.
In addition, all the tactics I covered in this week’s article are taught in our Certified Mortgage Advisor (CMA) course. There is even a PowerPoint presentation with slides that you can use to present this information to your clients, along with a coaching video you can watch to help you feel confident and comfortable presenting this information.
CMA teaches you about economic and housing reports, candlestick patterns, recession indicators and how to use mortgage debt to create sustainable lifelong wealth for your clients. This course empowers you to step away from being a salesperson so you can step into being an advisor for your clients.
This knowledge has made a powerful difference in my life and my career, which is why I’d like to offer you an exclusive $400 discount for this course. Simply use the code VISION upon sign up.
After all, investing in yourself today is the smartest financial decision you can make for your future success and your ability to help your clients build wealth through real estate.