Ever wonder how your home loan goes from a pain in your neck to real estate free and clear?
Well, it all has to do with a magical little thing called “mortgage amortization,” which is defined as the reduction of debt by regular payments of interest and principal sufficient to pay off a loan by maturity.
In simple terms, it’s the way your mortgage payments are distributed on a monthly basis, dictating how much interest and principal will be paid off each month for the duration of the loan term.
Understanding the way your mortgage amortizes is a great way to understand how different loan programs work. And an amortization calculator will show you how your balance is paid off on a monthly or yearly basis. It will also show you how much interest you’ll pay over the life of your loan, assuming you hold it to maturity.
Trust me, you’ll be surprised at how much of your payment goes toward interest as opposed to the principal balance. Of course, there’s not much you can do about it if you don’t buy your home in cash, or choose a shorter loan term, such as the 15-year fixed mortgage.
Early Payments Go Toward Interest
Pictured above is an actual “amortization schedule” from an active mortgage about five months into a 30-year fixed-rate mortgage. That means it’s got another 355 months to go!
Your mortgage lender or loan servicer may provide an amortization schedule calculator that you can use to see how your loan will be paid off. It can be helpful to make decisions about your mortgage going forward.
As you can see, the payment is $1611.64 per month. It doesn’t change because the loan is fixed, but the ratio of interest to principal does.
Early on, more than $1,000 of that $1,611.64 is going toward interest each month, with just over $500 going toward the principal balance. You want those principal payments to go up because they actually pay down your loan balance. The rest just makes your lender (and loan servicer) rich.
The good news is as you pay down your mortgage, the total amount of interest due will decrease with each payment because it’s computed based on the remaining balance, which goes down as principal is paid back.
And as that happens, the amount of principal rises because a fixed mortgage has a fixed payment too. So it’s a win win. Sadly, it doesn’t happen all that quickly.
During the first half of a 30-year fixed-rate loan, most of the monthly payment goes to paying down interest, with very little principal actually paid off. Toward the last 15 years of the loan, you will begin to pay off a greater amount of principal, until the monthly payment is largely principal and very little interest.
This is important to note because homeowners who continuously refinance their mortgages will find themselves back in the interest-paying portion of the loan every time they start anew, meaning they’ll pay a lot more interest over the years.
Each time you refinance, assuming you refinance into the same type of loan, you’re essentially extending the loan amortization period of the mortgage. And the longer the term, the more you’ll pay in interest. If you don’t believe me, grab a mortgage amortization calculator and you’ll see.
Tip: If you have already paid down your mortgage for several years, but want to refinance to take advantage of low mortgage rates, consider refinancing to a shorter-term mortgage, such as a 15-year or 10-year fixed mortgage. This is one simple way to avoid “resetting the clock” and stay on track if your goal is to pay off your mortgage.
Let’s look at a mortgage amortization example:
Loan amount: $100,000
Interest rate: 6.5%
Monthly mortgage payment: $632.07
Say you’ve got a $100,000 loan amount set at 6.5% on a 30-year fixed mortgage. The total principal and interest payment is $632.07 per month.
If you break down the very first monthly mortgage payment, $541.67 goes toward interest and $90.40 goes toward principal. The outstanding balance is reduced by $90.40, so next month you’ll only owe interest on $99,909.60.
When it comes time to make your second monthly mortgage payment, interest is calculated on the new, lower balance. The payment would remain the same, but $541.18 would go toward interest and $90.89 would go to principal. This interest reduction would continue until your monthly payments were going primarily to principal.
In fact, the 360th payment in our example contributes just $3.41 to interest and a whopping $628.66 to principal. A payoff calculator will illustrate this.
Consider Larger Mortgage Payments to Shorten Amortization Period
Okay, so now you have a better idea of how your mortgage amortizes or gets paid off. Your next move will be to determine if paying your mortgage down faster is a good idea.
In the example above, you’ll pay a total of $227,545.20 over the 30-year term, with $127,545.20 going toward interest. Ouch!
If you make slightly larger payments, say $700 each month instead (consistently), your mortgage term will be cut by roughly seven years (23 years total) and you’ll only pay $76,448.10 in interest. That will save you about $50,000 over the life of the loan…not bad.
If saving money is your goal, you can also make an extra payment here and there if you so choose, which can make a major dent in your loan balance. It’s actually pretty incredible how far a little extra goes in the mortgage world.
Conversely, you might be happy as a clam to pay your mortgage down slowly, seeing that mortgage rates are so low relative to other types of loans and/or investment options.
For example, if you can pay a rate of 4% on your home loan for 30 years and get a double-digit return in the stock market, what’s the rush? This is why some home buyers opt for adjustable-rate mortgages with no intention of ever paying off their loans, knowing they can do better elsewhere.
How Do I Pay Off My Mortgage in 10 Years?
Now let’s look at some specific ways to greatly speed up the loan amortization process. I’m providing ballpark estimates here, so do your diligence with a mortgage calculator to determine what works for your particular loan amount and mortgage rate. Results may vary.
How to pay off a 30-year mortgage in 15 years:
If you want to cut your mortgage term in half, simply figure out what the 15-year payment would be, then make that payment each month until the mortgage is paid in full. In general, this is about 1.5X the 30-year payment.
For example, a $350,000 mortgage set at 5% would require a monthly payment of $1878.88 in order to be paid off in 30 years. If you made the 15-year payment of $2767.78 instead, the mortgage would be paid off in 180 months, or 15 years.
How to pay off a 30-year mortgage in 10 years:
If you want to pay off the mortgage in just 10 years, the rule of thumb is to double your monthly mortgage payment. It’s not exact, but it’s very close.
Using our example from above, you’d need a monthly payment of $3712.29 to extinguish the loan in 120 months. Those with relatively small loan amounts might have no trouble doing this.
At the same time, it might be a big ask for someone with a jumbo mortgage who is struggling with affordability as it is.
How to pay off a 30-year mortgage in 5 years:
If you’re really impatient and want to pay off the mortgage in five years, you basically have to make anywhere from 3.5-4X the monthly payment. That’s $6,604.93 in our example to pay it all off in 60 months.
How to pay off a 15-year mortgage in 10 years:
If you have a 15-year fixed, but want to pay it down in 10 years, you can generally make a monthly payment about 1.5X and it’ll be paid off in 120 months instead of 180.
How to pay off a 15-year mortgage in 7 years:
To cut your 15-year mortgage term in half (or a bit more), doubling mortgage payments would pretty much lower the term to seven years or less, perhaps closer to 6.5 years.
How to pay off a 15-year mortgage in 5 years:
For those with a 15-year mortgage who want to triple the payoff speed, a monthly payment roughly 2.5X will get the job done.
You can do this same formula for basically any mortgage term and desired payoff duration. So if you have a certain payoff date in mind, figure out the number of months first, then plug in that monthly payment into a loan calculator to get the length of the mortgage down.
I should mention that mortgage rates are lower on shorter-duration home loans, so you may actually save more money by choosing a shorter loan term to begin with. However, you do get the added bonus of flexibility if you have a longer-term mortgage and paying extra is simply voluntary.
This is why a mortgage refinance from a 30-year mortgage to a 15-year fixed mortgage can be so powerful. Not only is the term shorter, but the interest rate is lower too. Sure, the payment amount will rise, but you’ll own your home a lot sooner and pay way less interest.
Take the time to learn about biweekly mortgage payments as well. These are payments made every two weeks, which equates to 26 total payments a year, or 13 monthly mortgage payments. That extra payment each year goes toward principal, lowering the total amount of interest paid and decreasing the term of the loan.
Every prospective homeowner should also take a look at an amortization schedule and/or a mortgage calculator to determine exactly how payments apply in their particular situation. Simply knowing your interest rate is not enough to make an educated decision on a loan product.
You’ll see how much impact even an eighth of a percentage point can make, which illustrates the importance of having an excellent credit score so you can obtain the lowest interest rate possible.
Read more: 30-year vs. 15-year mortgages.