I've been taking a Bible study offered by Crown Financial Ministries. It's a well put-together study that involves scripture memorization, Bible verse study, group discussion, practical exercises, and more.
This past week's topic was debt, and not surprisingly, the Bible doesn't have too many good things to say about debt 🙂 and encourages people to avoid almost all kinds of debt, and to get out of debt as quickly as possible.
Part of the discussion within one of the workbooks revealed a nice illustration of how paying extra on debt saves interest expense over the life of the loan. All that's needed is an amortization schedule.
Let's take a 30-year fixed-rate mortgage with starting principal of $100,000 and a rate of 5%. The monthly payment is $536.82. Here are the first five payments, split up by principal and interest, and the balance after making the payment:
| Pmt# | Payment | Principal | Interest | Balance |
| 1 | 536.82 | 120.15 | 416.67 | 99,879.85 |
| 2 | 536.82 | 120.65 | 416.17 | 99,759.20 |
| 3 | 536.82 | 121.16 | 415.66 | 99,638.04 |
| 4 | 536.82 | 121.66 | 415.16 | 99,516.38 |
| 5 | 536.82 | 122.17 | 414.65 | 99,394.21 |
For the first $536.82 payment, $416.67 goes to interest, and $120.15 goes to reducing the loan principal to $99,879.85.
Now let's say that I wanted to retire the loan faster by paying extra toward principal reduction. This saves me interest in the long run, but how much?
Let's say that I make an extra principal payment with my regular first payment. Let's say also that the extra principal is $120.65, which is the principal part of the second payment (in bold below).
My balance then is then $99,759.20. So, I've arrived at the loan balance I should have after the second payment, without paying the interest part of the second payment. Therefore, I saved $416.17 in interest by making an extra $120.65 payment when I did.
| Pmt# | Payment | Principal | Interest | Balance |
| 1 | 536.82 | 120.15 | 416.67 | 99,879.85 |
| 2 | 536.82 | 120.65 | 99,759.20 | |
| 3 | 536.82 | 121.16 | 415.66 | 99,638.04 |
| 4 | 536.82 | 121.66 | 415.16 | 99,516.38 |
| 5 | 536.82 | 122.17 | 414.65 | 99,394.21 |
That's one of the clearer explanations I've seen for how you save interest by paying down a loan faster.
Interesting exposition, but you only really end up saving money if your return on cash is lower than your mortgage rate. If you have other users for your money that can give you higher yield, you are losing money by overpaying.
I’m glad to see this post today. I’m about a decade ahead in my mortgage just from making additional payments to principal each month. It’s something I think everyone should at least look into, but it can be a difficult concept to explain. The charts you made make it easy to understand.
Oddly enough, I was just brainstorming about this yesterday and decided that I want to build an online tool to show people how much money they can save by making extra payments to principal. I’m planning on building a mortgage amortization calculator that will show how much interest you can save with a small lump-sum principal payment, or with small principal payments made on a regular basis. It would also show how much sooner the mortgage will come to maturity, since I know that’s a big motivational factor for me. Do you have any thoughts on this? If it would be beneficial to the personal finance community I’ll definitely follow through on making my idea a reality. 😛
I love those online calculators that show you how much you’ll save over years – decades! – by paying even $25 extra a month on your loan, or paying biweekly instead of monthly. It’s really incredible, and makes me wonder why more people don’t take advantage of the option.
I saved almost 2 years by doing bi monthly payments.
Certainly, the longer you take paying off the principal loan the more interest you pay along the way, and the higher the overall cost of the loan.
It would just be great if more people can see and understand how much more they pay when they take on debt. The human brain is just not good in intuitively grabbing that many small amounts together can be way much more than one big sum.
When paying my credit card debt, I always put in a little extra on what I’m suppose to pay so that little by little I am able to pay my debt and it lowers the interest that I need to pay for.