Can I pay a 30 year fixed loan like a 15 year fixed loan?

Question

I'm on a 30 year fixed loan with the following properties:

• 5% interest
• No penalty for early payments
• Pretty recent loan, hardly any equity

I'd rather be on a 15 year fixed loan, so that I can pay less in interest, and get more equity sooner. I don't think refinancing would make much sense for me, since my interest rate is not terrible, and I'd have to pay fees.

So my question is: If I just raise my monthly mortgage payment to the right amount, is that basically equivalent to being on a 15 year fixed loan? Is there any drawback to this?

Answer 1

"Can" is fine, and other answered that. I'd suggest that you consider the "should."

Does your employer offer a matched retirement account, typically a 401(k)? Are you depositing up to the match?

Do you have any higher interest short term debt, credit cards, car loan, student loan, etc?

Do you have 6 months worth of living expenses in liquid funds?

One point I like to beat a dead horse over is this - for most normal mortgages, the extra you pay goes to principal, but regardless of how much extra you pay, the next payment is still due next month. So it's possible that you are feeling pretty good that for 5 years you pay so much that you have just 10 left on the 30 year loan, but if you lose your job, you still risk losing the house to foreclosure. It's not like you can ask the bank for that money back. If you are as disciplined as you sound, put the extra money aside, and only when you have well over the recommended 6 months, then make those prepayments if you choose.

To pull my comment to @MikeKale into my answer - I avoided this aspect of the discussion. But here I'll suggest that a 4% mortgage costs 3% after tax (in 25% bracket), and I'd bet cap gain rates will stay 15% for non-1%ers. So, with the break-even return of 3.5% (to return 3 after tax) and DVY yielding 3.33%, the questions becomes - do you think the DVY top yielders will be flat over the next 15 years? Any return over .17%/yr is profit. That said, the truly risk averse should heed the advise in original answer, then pre-pay.

Update - when asked,in April 2012, the DVY I suggested as an example of an investment that beats the mortgage cost, traded at $56. It's now $83 and still yields 3.84%. To put numbers to this, a lump sum $100K would be worth $148K (this doesn't include dividends), and giving off $5700/yr in dividends for an after-tax $4800/yr. We happened to have a good 4 years, overall. The time horizon (15 years) makes the strategy low risk if one sticks to it.

Answer 2

To get a good estimate, go here or other similar sites and see. But basically, yes, you can save yourself a whole lot of money just by paying extra every month. One note though, do make sure you are specifying that you want the money to go towards principal, not escrow or toward prepaying interest.

Answer 3

You can definitely do it.

But: Refinancing would make more sense to you, you can refinance at no cost and get rates below 4%, so you'll be saving 1% a year, without paying anything extra. If you pay the fees you'll get even lower rates, but then you need to check whether its worth it.

I've just refinanced to a 15 years fixed mortgage at no cost a couple of months ago, and got 3.875% rate (in California), so its definitely worth looking into, don't just dismiss it.

This will limit your flexibility though, because paying 30yrs loan "as if" is much more flexible than committing on 15yes loan - you can always go back to your original payments if you want to spread it out a bit more. You can add a HELOC once you've accumulated some equity to back you up, that's what I did.

Answer 4

The can and the should have been discussed in other answers and comments, and so I will discuss the how. As others have noted, it is important to make sure that the additional money goes to reducing principal and not towards prepayment of interest. Unfortunately, very few bank tellers understand how mortgages work and very few bank officers - even loan officers - understand how mortgages work too. Thus a statement that you want the extra money to go towards principal will likely be met with a blank look. Furthermore, what they do with the money and how it is entered on the bank books that afternoon when the transactions are recorded may have no resemblance to what was discussed and agreed to earlier in the day. Based on my personal experiences and many arguments with banks about how they handled my prepayments and how interest was computed, I would recommend the following (which is easier now that automated payments are possible for the standard monthly payment and additional payments are possible via electronic funds transfer).

• Make sure that automated payments are made on the day that the payment is due, not at the end of the ten-day grace period that banks love to grant you for making the monthly payment. Yes, there is no penalty for late payment as long as you pay before the end of the grace period, but interest continues to be charged and so more of each graciously delayed payment goes to interest and less towards principal.

• Make the additional payment on the same day as the standard monthly mortgage payment is made. This ensures that at worst just one day's interest is owing when the additional payment is made. Also, payment in the middle of the monthly cycle is an almost sure way of getting ripped off on the interest because the bank's computers will post the payment in the manner most favorable to them, and usually contrary to the terms of your mortgage. I have complained to banks about mishandled mid-month payments and won every time, and on many occasions the bank officer would grudgingly say "We have always done it this way and nobody ever complained till you did today." I doubt very much if the bank's programs got changed as a result of my complaints. If you are not sure how mortgages work and how interest is calculated or don't have the time or inclination to go hassle with the bank each time but do prefer not to get ripped off, make the payment as described: on the dot and at the same time as the regularly scheduled monthly payment.

• The amortization schedule that the bank should have given you shows how much the principal amount is after the monthly payment is made on each due date. Assuming that you have not been taking advantage of the grace periods and so the schedule is correct, make an additional payment not of a round sum but an exact amount (down to the last penny) that will jump you from principal owing after today's regular payment to principal owing after the regular payment N months from today. Here of course you choose N based on how much extra money you were planning on paying towards your mortgage. By making the extra payment, you will effectively have cut the length of the mortgage by n months and the same amortization schedule will apply over the shorter period. Since very little of the principal is repaid in the early life of the mortgage, an additional principal-only payment can reduce the length of the mortgage by years. Paying a specific amount that matches the amortization schedule also helps if you ever need to hassle with the bank. It is their print-out you are arguing from, and not trying to explain to a clueless bank officer how the bank did not compute interest correctly after you paid $1500.00 extra at beginning of last month.

Answer 5

You definitely can under those conditions. Just be very careful to specify that you are making extra principal payments.

Answer 6

You also want to make sure that the loan is being re-amortized (sometimes called "recasting"). Without this, you are still responsible for the interest payments according to the original amortization table. If you re-amortize the loan with a principal that is lower than on the table, you will reduce the amount of interest you owe each period, which means that if you maintain the same payment you will pay less in total interest. It's important to realize that most people re-amortize to reduce the payment amount but not the term. Also, not all loans can be re-amortized, and some banks limit how often it can be done.