Homeowners can easily eliminate 10-15 years of payments on a 30-year mortgage by giving back a small but strategic amount of principal earlier than scheduled. In effect, recapturing 10-15 years of their careers, which is 10-15 years of former mortgage payments that become investment capital.
Most don’t realize they have this opportunity because they believe the lender stacked all the interest in the front of the repayment schedule, and won’t let them out of paying it. Actually, the repayment schedule is simply an assumption. It assumes you won’t pay more than the minimum. In fact, homeowners have the power to repay more than the minimum. In doing so, they hop-scotch down the original schedule, jumping over payments along the way. Next month, the normal payment will be automatically applied to their new position on the schedule.
For example, the normal payment is applied to #1. Repay the principal scheduled for payments #2, #3, and #4, for instance. Next normal monthly payment will be automatically applied to #5. Repay principal scheduled for numbers #6 , #7 and #8 at same time and next monthly payment will be applied to #9. The homeowner just eliminated an extra 6 payments by this process; 8 months altogether closer to paying off the mortgage by age 50-55.
All of which is based on nothing more than simple arithmetic!
(Remember, you can never skip a normal monthly payment. Interest must be paid and brought current every month. Any additional money automatically goes toward principal, reducing the outstanding balance, which will correspond to a payment further down the original schedule.)
It takes only a small amount of principal because there’s very little principal in the beginning of the repayment schedule. Accelerate principal repayment there and hop-scotching down the repayment schedule doesn’t take much money. Wait until later and it’ll cost much more. It’s “strategic” because it attacks only the front of the repayment schedule.
Critics of “early” repayment are confused. Their confusion is rooted in thinking the annual interest rate is the true cost of an amortized mortgage, 7 percent for instance. Thus, it doesn’t matter when principal is accelerated. In fact, there’s a major difference between the interest rate and interest expense. The former is an annual percentage, the latter is cash. The average during the first five years of a 7 percent 30-year mortgage, for instance, is actually more than $4 for every $1 of scheduled principal reduction. In other words, if you don’t repay that $1 “early,” you’re forced to pay $4 of interest expense. There’s no third choice.
Not only are they wrong about the true cost of a mortgage, but also mistaken about the central purpose of accelerating principal. They think it’s to save money and saving 7 cents on the dollar, for instance, isn’t worth it. Not only is it $4 of scheduled interest expense, but eliminating the time scheduled to pay it. Simply put, the real objective is to recapture that time, preserving a good chunck of career for a retirement account. Saving the $4 of scheduled interest expense is good, preserving 10-15 years of career is worth more than money. Time is the one resource there isn’t enough of, once it’s gone it can never be recaptured.
This is a prime example of assumptions that sound good, but aren’t true. This is why everyone must examine such assumptions closely and ensure they still apply to the current situation.
No “But” About It … Millennials can indeed afford to pay off their mortgage by age 50-55. Contrary to their fears, all they need is a little know-how, insights into how to leap over the lazy” sections of the repayment schedule, i.e. repay a strategic amount of principal, and eliminate the payments previously scheduled for that principal. This is how they can recapture 10-15 years of their career, adding the time and money to their retirement account.
Strategic Repayment was essential in earlier times and it’ll be essential in the New Normal too.
Nuts and Bolts
Even though the concept is simple and easy to understand, it would be helpful to provide more insights.
Total Payments: You can get a good idea of how much principal in total will be required to recapture x number of payments/months. Simply subtract the ending balance at one scheduled payment and the balance at another payment. For example, between payment number 36 and 156. That’s the amount of principal to repay in order to recapture those 120 payments. (Plus, some extra money for repaying it over time.)
(Payments are taken off the front of schedule where interest expense is the highest, not the back. The back preserved for normal payments because that’s where most of the principal reduction is located.)
Guidelines: Plan on finishing early repayments by payment #240. Two reasons, (1) You want to save the last 10 years for normal monthly payments because each payment has a lot of principal, finally getting “your money’s worth.” (2) Conversely, it means it’s also too expensive to buy-back a month of scheduled payments. Indeed, what you recapture by payment #240 is probably all the time you’re ever going to buy back early.
Five to seven calendar year program. After all, if you’re going to eliminate an extra 120-180 payments by #240, after all, you’ve only got 60 to 84 calendar months. to do it. Especially if you’re starting three years or 36 months into the repayment schedule.
Incremental Method: Sticking to the original repayment schedule lets you plot your budget for months and years down the schedule. You can monitor the proper application of extra principal. Your balance and the lender’s balance shouldn’t match perfectly. (Lenders can get confused, classifying it as “prepaid interest” when there is no such category.) Importantly, you can see if you’re on track to recapturing enough payments for that cash nest egg.
The following is a repayment schedule on a 30-year, $143,000 mortgage, at 7.5 percent interest (historical average), $999.88 monthly P&I payment. It represents the minimum requirement, a projection or assumption if there are no early repayments. In fact, once interest is brought current by the normal monthly payment, any and all additional money is automatically applied to principal reduction. Interest due the following month is on actual balance after the additional principal, not the presumed balance.
| Payment | Principal | Interest | Balance |
|---|---|---|---|
| 1 | $106.13 | $893.75 | $142,893.87 |
| 2 | $106.79 | $893.09 | $142,787.08 |
| 3 | $107.46 | $892.42 | $142,679.62 |
| 4 | $108.25 | $891.75 | $142,571.37 |
Since interest due on $143,000 is $893.75 ($143,000 x .075 %/ 12 months = $893.75), the remaining $106.13 of $999.88 payment goes to principal. Presuming the homeowner adds $241.25 to the payment ($106.79 + $107.46 for payments #2 and #3.), the ending balance would be $142,679.62.
The accrued interest next month will be $891.75, which corresponds to payment #4. Normal monthly payment next month will be automatically applied to #4. This means payments #2 and #3 have been eliminated, recapturing two months of career. This is how homeowners can hop scotch down the repayment schedule.
Ideal plan is to start by eliminating five payments per month, then backing down to four, three, and then two payments as they become more costly. Once a year, an extra lump-sum payment goes along way to preserving last 15 years of career for retirement account; annual bonus, tax refunds, and similar sources of extra money.
Advantage of “incremental method” is it’s a good road map, helping you budget for months and years ahead, ability to track progress, and make adjustments if necessary.
You can also repay principal according to money available, the “convenience method.” Advantage of convenience method is simplicity. But, it’s also in danger of slipping away. Competition for money is fierce, and it’s often the first to go.
Finally, there’s the “lump-sum” method, i.e. once or twice a year repayments. This works for those who don’t get monthly paychecks, seasonal work for instance. Also for those who earn commissions. Others get annual bonus from work. Some combine incremental payments with bonus payments.
All paths lead to Rome, so long as you stay on the road.
A Last Word: There’s no mystery or magic about strategic repayment, simply give back the money and buy back the time.. The “incremental method” is a good road map, but all methods will work. So long as you diligently give back the money, it really doesn’t matter which one you use.
Early repayment may be involved but it’s not complicated. Anyone who was competent enough with all the paperwork and qualified for a mortgage is proof they have the skill and talent to implement this program.
(For those who may want a more detailed explanation of how an amortized mortgage is constructed, and why principal acceleration can easily deconstruct it, can order the book, “Nest Egg Strategy” on Amazon. )
