401(k) 2013.
There's one thing every homeowner should consider doing as we move into 2014 that could save them thousands of dollars.
Put simply: By saving a little more each month, attempt to pay more than your mortgage payment requires.
With interest rates now moving upwards from their all-time lows, many people have taken advantage of the refinancing boom and are now looking at a monthly payment at a wonderfully low rate. Yet more savings can be had by simply paying more each month than what the mortgage says you should.
Consider these scenarios and the possible savings associated with them to see what a radical difference as little as $50 a month can make over the lifetime of a loan.
Make your prior payment amount
To start, there are millions of Americans who have taken advantage of the radically low rates of the last few years and refinanced their existing mortgage. In an example of someone with a $200,000 mortgage at 6%, refinancing to 4.5% would result in the monthly payment falling from $1,200 to $1,015, a savings of $185 a month.
Over a 30-year mortgage, that would result in a total savings of nearly $67,000, so that person would likely be quite happy with their current financial position. However, those savings could be even greater if they made their prior mortgage payment of $1,200 on their new mortgage. By simply making the same payment at the prior rate, the individual would save an additional $50,000, netting them a savings of more than $115,000 over the lifetime of the loan versus their prior mortgage:
The additional payment would result in the mortgage being paid off more than eight years sooner. If that payment of $1,199 was simply put into saving account each month for those eight years, that would mean an additional $115,000 stored away in savings, and that excludes any potential interest that could be earned.
Each person's financial circumstances are different, and at times, the thought of returning to a mortgage payment equivalent to the amount prior to refinancing makes people sick to their stomachs, but for others, a refinanced amount simply just meant more disposable income, and they would do well to actually plow that money back into their mortgages to further compound their total savings.
Even $50 a month can make an enormous difference
$185 is no small amount, so even if that was cut to an additional payment of just $50, it can result in a total savings of almost $18,000 over the course of a 30-year $200,000 mortgage at 4.5%. In addition, the mortgage repayment length will be shortened by almost three years.
Even if there are only 20 years left on that same mortgage, the savings stand at almost $7,000, and the mortgage is paid off almost a year and a half sooner.
As a final example, instead of paying $1,013, if a person paid just $7 more, making a nice round payment of $1,020, it would mean the mortgage being paid off five months sooner and a total savings of $2,500.
Don't neglect savings
All of these examples presuppose that the additional money put into the mortgage is always done in addition to other savings. Paying off a mortgage early at the expense of savings for retirement isn't usually an intelligent move because what you pay on your mortgage is often much lower than what you could earn in a simple S&P 500 index fund.
Consider the past example of putting the $185 each month toward your mortgage. If you in turn saved that $2,300 each year and put it into a savings account and a simple S&P 500 Index Fund that historically has returned around 7% each year, at the end of 30 years, you'd have a little over $225,000. In the past example, you saved "only" $165,000, but that's all without an potential interest being accrued on those savings.
If you'd be able to return 7% annualized over the eight years when you weren't making any mortgage payments, that return jumps from $115,000 to $150,000, so the gap is narrowed considerably. Over a narrower time frame of eight years, the risks are greater.
Understand your options
It must also be noted that there may be a potential prepayment penalty on certain mortgages, and each individual's financial circumstances are different. Paying more than what your mortgage requires can yield significant savings, but with mortgage rates at historically low levels, by investing the same amount, the return may be greater depending on your situation.
