Delaware Business Lawyer Blog

A few warnings are in order.

(1) Before you make any prepayments of principal, you need to check the promissory note you signed when you obtained your mortgage to verify that prepayments are allowed without penalty.

(2) When you send in your mortgage payment, include a note indicating that your payment includes an additional payment of $ (insert dollar amount), and that the additional amount should be applied to principal. Keep a copy of the note with your amortization schedule. On the other hand, if you have a mortgage coupon and it has a line where you can insert the extra principal payment, you can use that instead of a note.

(3) Make sure your mortgage company is applying your prepayments correctly. Sometimes, mortgage companies apply the prepayment to something other than principal, and that won’t do you any good. On a regular basis, you should check to see that your mortgage company has applied your prepayments correctly. This is easy to do. Compare the balance that your mortgage company says you owe with the balance that your amortization schedule shows you owe. You can check the mortgage company’s records by phone, on the web, or by looking at their monthly statements. With your amortization schedule in front of you, and your notes that you sent in with your checks, proving to the mortgage company what your correct balance is will be pretty easy.

(4) Although I’ve given you a link for an amortization schedule to explain the concept of making prepayments, you should use an your amortization schedule supplied by your mortgage company so that you’re both using the same figures. Otherwise, the numbers will not match and you won’t be able to verify your exact balance. If you don’t receive an amortization schedule at your settlement, contact your mortgage company and they will send you one.

In my article entitled "Prepaying Your Commercial Mortgage," I introduced the concept of using your amortization schedule to make prepayments. In this article, I'll show you how to do it.

Suppose when you make your first mortgage payment, you add an additional $250.12 to your payment. That’s the principal portion of payment number two. Let’s look at what you have accomplished by paying the additional $250.12.

First, your principal balance after just one month would be $249,501.00 instead of $249,751.12.

Second, you save $1,248.76 because you don’t have to pay interest on $249,751.12. Why? Because your principal balance went from $250,000.00 to $249,501.00.

Third, you just took one month off your mortgage because in one month, you made two payments of principal ($248.88 and $250.12). If you did this every month, your mortgage would be paid in full in 15 years!

If you pay the additional $250.12 when you send in your 1st payment, draw a line under payment number two (see figure 2) so you’ll know the breakdown for your next payment and so you can see what your balance is. Put a bracket around the numbers one and two, and write beside the bracket the month and year of your first monthly payment (for example, August 2008).

When you get to your second monthly payment, you will be at payment number 3. Add to your regular payment $252.63 (that’s the principal owed in payment number four). If you do that, your balance would be $248,997.00. And, you will have saved an additional $1,246.25 in interest. Draw a line under payment number four, put a bracket next to numbers 3 and 4, and write September 2008 next to the bracket. Consider this. By making a prepayment of principal in your first and second month, it costs you an additional $502.75 ($250.12 plus $252.63, but you save $2,495.01 in interest in just two months).

Over 5 years, the savings are dramatic. If you make no prepayments of principal, after the first 5 years you will be at payment number 60, and your principal balance will be $232,635.66. By making a prepayment using the method I’ve described, after 5 years you will be at payment number 120, and your principal balance will be $209,213.76. In just 5 years, you will have $23,421.90 more equity, and you will have saved $69,488.83 in interest.

If you do this every month, you will pay off your entire mortgage in only 15 years. Using the 6%, $250,000.00 mortgage example, you will save $144,484.94 in interest.

How would you like to save $69,500.00 in just 5 years? I’m going to show you how to do it. Of course, the amount you save will depend on the size of your mortgage and your interest rate, but let’s assume by way of example that you take out a 30 year mortgage for $250,000.00 at 6% interest. The killer is the amount of interest you have to pay. Over the 30 years, your payments of principal and interest will total $539,595.47, of which $289,595.47 is interest.

That’s almost $40,000.00 more than you originally borrowed!

Many of us have heard that you can save a great deal of money if you pay more than your regular monthly payment. It’s true. You can save thousands of dollars in interest, and pay off your mortgage in just 15 years. Even if you don’t stay in the same property for 15 years, making prepayments of principal guarantees you will build equity a lot faster, and when you do sell the property, you will walk away from the settlement table with more cash in your pocket.

There are different ways to make prepayments of principal, but in my opinion, the best way is to use an amortization schedule and follow the method which I describe below. Let’s stay with the example of $250,000.00 and an interest rate of 6%. Each month, your payment of principal and interest is $1,498.88. This payment stays the same for the full 30 years. What changes every month is how much of your payment goes to principal, and how much goes to interest. In the earlier years, most of the money you pay is interest.

In Figure 1, you can see the amortization schedule for the 1st 12 months.

In the first month, $248.88 of your payment is applied to principal, and $1,250.00 is applied to interest. When you subtract $248.88 from the original loan of $250,000.00, the principal balance after the first payment is $249,751.12.

In order to use the complete 30 year amortization schedule, insert the following information:

Principal: 250000.00
Number of Regular Payments: 360
Payments Per Year: 12
Annual Interest Rate: 6.0

Then place a check in the box called “Show Amortization Schedule,” and click on the "Calculate” button. The amortization schedule shows on a monthly basis how much of your payment is applied to principal and interest, and what your mortgage balance is after each payment.

If you've ever borrowed money from a bank or mortgage company, you’ve probably heard about amortization schedules. It’s a month by month schedule that shows precisely how your loan will be repaid. The amortization schedule lists the required payment on each specific date, how much of each payment is interest, and how much of each payment is applied to principal.

Some lenders include an amortization schedule in the documents you receive when you sign the loan documents. These schedules are also available on-line. For example, you can get a very nice schedule for free at the following website: http://ray.met.fsu.edu/~bret/amortize.html

When you create an amortization schedule on the internet, you’ll need to have available the following information:
1. The amount of your original mortgage
2. Your annual interest rate
3. The number of monthly payments per year (12)
4. The number of monthly payments you will make over the entire life of the loan.

You can use your amortization schedule to help you make prepayments of principal, to keep you up to date on your mortgage balance, and to verify that your lender has been properly giving you credit for each of your monthly payments.

Note: For detailed information about how to use your amortization schedule to make prepayments of principal, see my next article entitled “Prepaying Your Commercial Mortgage.”