Everyone, say hello to Catherine! She's not a real person, just a fictional character I made up for illustrative purposes, but let's take a quick look at her situation. She's a teacher, and she makes $60,000 a year.
Catherine just bought a condo for $265,000 with a 20% down payment, on a 30-year loan, at 3.75% interest. Catherine’s principal is $212,000 because her down payment was so her monthly payment is about $980.00. Let’s say for simplicity’s sake that there are no HOA (homeowner's association) or condominium fees. Let’s also stipulate that Catherine should spend no more than 30% of her income before taxes on housing. Given this 30% rule, $980 is a very comfortable monthly payment-- actually several hundreds of dollars under her maximum-- so Catherine can certainly voluntarily give the bank more than that much money each month to generate great savings down the line.
Catherine knows this advantage exists, so she gives the bank $1500 instead of just $980 each month (which is only 19.6% of her income before taxes each month), and she asks that the difference be applied to the principal, building her equity in the condo faster than if she stuck to the bank’s 30-year schedule. She could be done paying off the condo in 17 years and 6 months—rather than 30 years—and she would save about $69,330 in interest. These savings come as a consequence of the fact that the principal decreases faster if Catherine specifically applies the extra money to the principal, and so since the interest she pays is proportional to how much principal is left, with a smaller remaining principal, Catherine pays less interest overall by staying ahead of her amortization schedule.
Depending on the lending institution, you may have to physically be present at a branch to ask them to apply the extra money you want to give them toward the principal, or you may be able to do this by writing that request on the memo/note line of a check or over the phone or online, without having to be at the brick-and-mortar bank.
Catherine just bought a condo for $265,000 with a 20% down payment, on a 30-year loan, at 3.75% interest. Catherine’s principal is $212,000 because her down payment was so her monthly payment is about $980.00. Let’s say for simplicity’s sake that there are no HOA (homeowner's association) or condominium fees. Let’s also stipulate that Catherine should spend no more than 30% of her income before taxes on housing. Given this 30% rule, $980 is a very comfortable monthly payment-- actually several hundreds of dollars under her maximum-- so Catherine can certainly voluntarily give the bank more than that much money each month to generate great savings down the line.
Catherine knows this advantage exists, so she gives the bank $1500 instead of just $980 each month (which is only 19.6% of her income before taxes each month), and she asks that the difference be applied to the principal, building her equity in the condo faster than if she stuck to the bank’s 30-year schedule. She could be done paying off the condo in 17 years and 6 months—rather than 30 years—and she would save about $69,330 in interest. These savings come as a consequence of the fact that the principal decreases faster if Catherine specifically applies the extra money to the principal, and so since the interest she pays is proportional to how much principal is left, with a smaller remaining principal, Catherine pays less interest overall by staying ahead of her amortization schedule.
Depending on the lending institution, you may have to physically be present at a branch to ask them to apply the extra money you want to give them toward the principal, or you may be able to do this by writing that request on the memo/note line of a check or over the phone or online, without having to be at the brick-and-mortar bank.
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