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If I can afford to supplement the monthly mortgage payment, where should the extra money go: on the PRINCIPAL? Or on the INTEREST section?

I'm a first-time homebuyer and have my first mortgage payment coming up on a 30-year, fixed. Have read in Kiplinger and elsewhere that it makes financial-sense to bump up that mortgage payment a bit each month to possibly trim the length of that mortgage to 25 years or so. If I can afford to supplement the monthly payment, where should the extra money go: on the PRINCIPAL? Or on the INTEREST section?

Jan 10, 2012 by Cydney from Whittier, CA in  |  Flag
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David Kleinik Level 15

Cydney,

the extra should go to the PRINCIPAL every time, all day long, no reason not to. Allow me to explain - the interest on you mortgage that you pay monthly is calculated off your current principal meaning not only do you knock out some principal but you are knocking down the interest you pay monthly which in turn means your regular payment is knocking out more Principal. NOW when you make that payment make sure you mark it as a principal payment only otherwise the company might apply it to both principal and interest! ALSO another thing to look at is bi-weekly payments it is a program where you pay half on the 1st and half on the 15th but it knocks out 8+ years on your mortgage because of the way interest is calculated!!!

David Kleinik

Comment   |  Flag   |  Jan 31, 2012 from Jacksonville, FL

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Jonathan Foster Level 16

Hi Cydney,

Assuming you have a traditional 30-year fixed mortgage, generally, if you overpay the amount due, the extra goes to reduce your principal balance. It's a good idea to write what the payment is for in the memo section on your check. This effectively shortens your mortgage, saving you interest over time. This is a great strategy to reduce your obligations, long-term. Your payments won't get smaller, but you will be finished with them sooner.

In fact, there is a school of thought that locking in a 30-year mortgage (at today's low interest rates) may be preferable to taking down a 15-year mortgage (even though the rate might be a little cheaper). The reason is that you have locked in cheap money for the long term, and the ability to pay off your mortgage in a shorter period is COMPLETELY IN YOUR HANDS. There is no bank demanding that you pay off your mortgage in 15 years, but you can certainly do so if you wish. Additionally, times change! You may have financial flexibility right now to pay down, but in the future, you might not be so liquid. Taking down a long fixed mortgage at low interest rates give you a lot of flexibility to prepay, or not, depending on your current situation.

Make sure to check with your lender to confirm the above, and that there are no pre-payment penalties, etc.

Jon Foster

Comment   |  Flag   |  Dec 27, 2012 from Santa Monica, CA

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It should be applied to your principle as that will reduce the interest for the future. Be sure to check with your mortgage holder and verify that there is not a prepayment penalty. In this low interest market paying off your mortgage is a wise choice and anything you can do to reduce will help you in the future.

Comment   |  Flag   |  Feb 14, 2012 from Raleigh, NC

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If you are making extra payments, you need to check with the lender's order of payment outlined in your mortgage documents. In almost all cases, extra payments not otherwise specified will be applied to late charges, interest and escrows before being applied to principal reduction.

If you have a fixed-rate mortgage and you are not delinquent, then your extra payment will only be able to be applied to principal. Ultimately, this will reduce the term on your loan and you'll "save" on the interest you are not paying to the lender because you paid off the loan early.

On the other hand, if you have an adjustable rate mortgage (ARM), then the extra payments are applied and will not reduce the term (all ARM's are for 30-years) but your total interest will be less. As you make a payment, the next month's payment is calculated based on the newly reduced loan balance at the current interest rate.

The question not asked is should you be prepaying on the loan before making sure that you have fully funded your emergency reserves (ranging from 3 to 12 months depending on how many earners there are and the type of/consistency of income) and paid yourself first through your retirement plan contributions.

Comment   |  Flag   |  May 17, 2012 from Amesbury, MA

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Principal, that way you are paying down the money owed. I would double check with your mortgage consultant as well.

1 Comment   |  Flag   |  Jan 10, 2012 from Boston, MA
Guy

The whole idea of paying extra is so you can reduce your principal. If you put it on the interest, that only reduces your payment the next month. If you put it onto the principal, it means more of your payment will go to principal reduction in the next month. So by all means, apply it to the principal. Hope this helps.

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Flag |  Jul 28, 2013 near Irvine, CA

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Tunc Tanin Level 10

While Kiplinger and Money magazine's used to say that it is a good idea to shorten your mortgage, then the rates were much higher. Also you may be able to afford it now,, but can you afford the extra payment in the future. One problem with paying off a mortgage is that it is not a very liquid solution. If you loose your job, you can not get that money out of real estate easily. An investment account has much more liquidity. I have seen clients with 30,000 credit card debt and 60,000 home equity due to the extra principal payments, they were clearly better off paying the credit card first.

Comment   |  Flag   |  Sep 22, 2014 from Somerville, MA

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