Everyone likes to save money on loans and mortgages. There are different ways to do this. You can get a lower interest rate, pay the principal in less time or make periodic lump sum payments. The question is: which ways save you the most money and are the least painful? Let's find that out.

We begin with a loan of $10,000 at 8% annual percentage rate (APR) over 5 years. Using the loan calculator on mathwizz.com, we find the monthly payments are $202.76 and the total amount of interest paid is $2,165.60.

What if you got a lower interest rate like 7%? Then the monthly payments are $198.01 and the total interest is $1,880.60, saving you $285.00

But, getting a lower APR is not as effective as paying off the loan sooner. Taking our example of $10,000 at 8% APR, if you pay it off in 4 years instead of 5, the monthly payments are $244.13, which means you'd have to scrape up an extra $41.37 a month, but the total interest is $1,718.24, saving you $447.36. This table shows the whole picture.

Loan Amount | APR | Term | Monthly payment | Total interest | Savings |
---|---|---|---|---|---|

$10,000 | 8% | 5 years | $202.76 | $2,165.60 | - |

$10,000 | 7% | 5 years | $198.01 | $1,880.60 | $285.00 |

$10,000 | 8% | 4 years | $244.13 | $1,718.24 | $447.36 |

If you can save that kind of money on a loan by paying it off sooner, imagine how this would work for a mortgage.

If you had a $100,000 mortgage at 6% APR amortized over 25 years, the monthly payments would be $644.30 and the total interest $93,290.42. If you could cut the amortization to 20 years or even 15 years, look at the money you would save:

Term | Monthly payment | Total interest | Savings |
---|---|---|---|

25 years | $644.30 | $93,290.00 | - |

20 years | $716.43 | $71,943.20 | $21,346.80 |

15 years | $843.86 | $51,894.80 | $41,395.20 |

Pretty impressive, wouldn't you say?

Wonderful, you say, but, for instance, to cut the amortization to 20 years from 25 years, I'd have to come up with an extra $72.13 a month, and that would cut into my lifestyle. Isn't there an easy, painless way to pay down my mortgage and save money?

Well, yes there is. For this method to work, I'm going to assume that you are a bona-fide citizen and that you pay income tax once in a while. I'm also going to assume that once a year, you get an income tax refund. The way this works is that once a year when you get your refund, you take part of it and apply it to your mortgage. If your lender won't let you do that, maybe you should be looking for a new lender. Anyway, let's use the above example again.

If you could pay a lump sum of $889.76 once a year, you could keep the same monthly payment of $644.30 but the mortgage would be paid off 5 years sooner and the total interest would be $72,427.20 saving you $20,863.20. Not bad, eh?

That's nice, you say, but my income tax refund isn't the size of Fort Knox. What if I only have $200 a year to spare?

Well, the answer is that even if you made an annual lump sum payment of only $144.06, it would still knock a year off your 25-year mortgage down to 24 years and the interest would drop from $93,290.42 to $89,015.84, still saving you $4,274.58. So even a little bit is better than nothing.

By the way, you may have noticed with the 20 year amortization that you save more money with higher monthly payments than with an annual lump sum payment. This table shows the difference on the $100,000 20-year mortgage at 6% APR.

Monthly payment | Annual lump sum payment | Total interest | Savings |
---|---|---|---|

$716.43 | 0 | $71,943.20 | $21,346.80 |

$644.30 | $889.76 | $72,427.20 | $20,863.20 |

As an aside, some weekly and bi-weekly mortgages apply this idea. What they do is take your monthly payment and split it into 4 payments for weekly-pay mortgages or 2 payments for bi-weekly. In essence, what you're doing is paying 13 months in 12.

For instance, taking our example of $100,000 at 6% APR, if you could pay $330.22 every 2 weeks, you'd have the mortgage paid off in 20 years and the total interest would be $71,714.40. If you chose a weekly-pay mortgage instead, it'd be $165.01 per week for 20 years and the total interest would be $71,610.40. All you did was switch payment options. Let's compare everything on a $100,000 mortgage at 6% APR.

Payment frequency | Amortization period | Payment | Total interest | Savings |
---|---|---|---|---|

monthly | 25 years | $644.30/month | $93,290.00 | - |

monthly | 20 years | $716.43/month | $71,943.20 | $21,346.80 |

bi-weekly | 20 years | $330.22 every 2 weeks | $71,714.40 | $21,575.60 |

weekly | 20 years | $165.01/week | $71,610.40 | $21,679.60 |

As you can see, bi-weekly and weekly-pay mortgages are the way to go.

To summarize, the best ways to cut your mortgage are:

- convert to bi-weekly or weekly pay mortgage.
- if you're going with a monthly-pay mortgage, increase your monthly payment to reduce the amortization.
- make regular lump-sum payments.
- reduce the interest rate.

Happy saving!

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