Starbuck's or Not?

The Effects of Paying an extra $100 a month on the Mortgage

by Ruth M. Naugle

What difference would it make to skip the morning coffee and add the money to the monthly mortgage payment? A cup of coffee is not that expensive, but the money adds up over time. Let's say that one bought a $3.00 cup of coffee every morning. Over a month, this would be approxiamately $100.00. Let's see the effects of adding this money to the mortgage payment.

**The Mortgage Payment**

Bob is obtaining a loan for $100,000. The
bank suggests that Bob apply for a 30-year fixed mortgage since the interest
rates are down to 6.5%. To determine the monthly payment, the following
formula is used.

M=(Pr(1+r)^n)/((1+r)^n-1)

where

M = monthly payment

r = monthly interest rate

(.065/12)

n = number of payments

(12 months for the next 30 years)

12*30 = 360

P = Principal

($100,000)

Using the formula Bob determines his monthly payments will be $632.08, not including escrow. Wow, that's less than he is paying for rent!

As Bob is planning for his loan, he thinks of the cost
of the loan over the next 30 years. Bob pays 632.08 each month for the
next 30 years, then he will pay a total of $227,548.80. To find the
amount he will pay in interest, he will subtracts the principal from the
total paid.

$227,548.80 - $100,000 = 127,548.80

Over $120,000 in interest seems like a lot of money to
just pay the bank.

Click here to see Spreadsheet

This has Bob thinking of ways to reduce the amount of interest he pays. There are several ways to reduce the interest. First, one can make a larger down payment to decrease the principal. Second, one can try to obtain a lower interest rate. Third, one can pay additional money each month towards the principal. Since Bob does not have additional money for a down payment and 6.5% is already a low interest rate, Bob looks into putting additional money towards the principal. Skipping the morning coffee would save @$3.00 a day over @30 days a month, or about $100.00 a month. What effect would it have on the loan if this money was paid toward the principal of the loan each month?

**Additional Mortgage Payment**

Bob calculates his new mortgage payment
will be $732.08, with $100.00 going towards the principal. This loan
will not take 30 years to pay off, but only 21 years! The total amount
paid is $182,502.77. Subtracting the principal from the total paid,
he determines he will pay $82,502.77 in interest. Although that still
seems like a lot of money, that is $45,032.78 less than paying off the
loan in 30 years.

Click to see spreadsheet

Once he pays off the house in 21 years,
what will he do with the additional money. Why not invest it!
Bob decides to put the $732.08 into an account earning 4% compounded annually.
He continues invest $732.08 each month from year 21 to year 30. At
the end of the 30 years the account will have grown to $98,151.47.
If Bob decides to pay $632.08 a month he will finish paying off the loan
in 30 years. However, if Bob pays $732.08 a month, then he not only
pays off the loan 21 years, but has almost $100,000 in an account.
This seems like a great idea since only $36,000 ($100 a month for 12 months
for 30 years) more has been invested.

Return to Naugle's Homepage