Getting started in real estate? It’s almost like picking up a whole new language, right? You’re trying to decode a whole new set of terms and concepts. Words like “equity,” “interest,” and “amortization” are thrown around, and right at the center of it all is the term “mortgage principal.”
Let’s talk about these and break down what they all mean.
You’ve found the house for you. The yard is just right, the kitchen is dreamy. It even has that little nook you’ve always wanted. The seller wants $400,000 for it.
Let’s say you’ve saved up a hefty $80,000 for the down payment. That’s fantastic! The remaining $320,000 that you’ll be borrowing. That is the mortgage principal.
The mortgage principal is the heart of your home loan. It’s the amount you’re borrowing from the lender to buy your piece of paradise.
You’ll send a check (or, more likely, an electronic payment) to your lender each month. This payment is a combination of principal and interest. Initially, a more substantial portion goes towards interest.
But as the years roll by and you reduce the principal, the interest portion shrinks, and more of your hard-earned money attacks the principal. It’s all about momentum!
What About the Principal?
While your principal starts as a fixed amount, several factors can change how quickly you pay it off:
1. Adjustable-Rate vs. Fixed-Rate Mortgages
Most of us opt for a fixed-rate mortgage. It’s like having the same delicious breakfast every day; no surprises. But some brave souls choose the adjustable-rate mortgage (ARM). With an ARM, interest rates can fluctuate, changing your monthly payments and their split between interest and principal.
2. Making Extra Payments
Got a bonus? Inherited some money? Or you could save on expenses. Pouring this into your mortgage can reduce your principal faster, saving you on future interest.
Imagine the market has shifted, and interest rates are now lower than when you got your original loan. Refinancing lets you snag that lower rate. This can change your monthly payment amounts and how quickly you reduce that principal.
The Benefits of a Shrinking Principal
Chipping away at your mortgage principal is like working out; the benefits are numerous:
- Less Interest Paid – Every dollar you knock off the principal reduces the interest you’ll pay over the life of the loan.
- Increase Home Equity – The difference between your home’s value and what you owe is your equity. As the principal drops, your equity rises.
- Peace of Mind – Owing less money? That’s always a good feeling, right?
- Increased Financial Flexibility – With a reduced principal, you have more wiggle room in your finances. It might provide an opportunity to explore other investments or manage unexpected expenses.
- Higher Potential for Refinancing – As the principal drops, it can improve your loan-to-value ratio, making it easier to qualify for refinancing opportunities in the future.
- Improved Credit Profile – Consistently reducing your principal can positively impact your credit score.
Tips to Reduce Your Principal Faster
For those eager beavers looking to gain the upper hand on their principal:
1. Round Up Payments:
If your monthly mortgage payment is $1,500, consider rounding it up to $1,600 or even $1,700.
This little extra can compound over time, making a big difference. Even an extra $50 monthly can shave off years and a significant interest from your mortgage.
If you get a raise or find extra wiggle room in your budget, this is a painless way to accelerate your mortgage payoff.
2. Bi-weekly Payments:
Instead of making 12 monthly payments yearly, you make half monthly payments every two weeks.
By the end of the year, you’d make 26 half-payments, equating to 13 total payments. That’s one extra full payment annually!
Check with your lender if they offer a bi-weekly payment structure. If they don’t, you can achieve the same result by making one extra monthly payment each year.
3. Refinance to a Shorter Loan Term
If you initially took out a 30-year mortgage, consider refinancing to a 15-year term. Shorter-term loans usually come with lower interest rates.
Plus, with a shorter term, a more significant portion of your payments goes towards the principal rather than interest.
Before refinancing, understand any associated fees and calculate the long-term savings to ensure it’s a beneficial move.
4. Allocate Windfalls and Bonuses
Dedicate unexpected financial windfalls towards your mortgage principal—like tax returns, work bonuses, or inheritance money.
These aren’t funds you typically count on in your monthly budget. Using them to reduce your principal can dramatically decrease the loan’s lifespan and the interest paid.
Got a $2,000 bonus at work? Instead of splurging it all, consider putting a substantial portion, say $1,500, directly to your principal and treat yourself with the remaining $500.
5. Make One Extra Payment Annually
Without stretching your monthly budget, make one additional mortgage payment anytime during the year. This could be from a bonus or savings and adding that amount to each payment.
This adds up to one extra full payment over the year. This tactic can cut down several years from your mortgage term, especially if done consistently.
If you receive an annual bonus, allocate a portion or the entirety of it towards this extra payment. Alternatively, set aside a small monthly amount in a separate savings account, and when it accumulates to your monthly mortgage amount, make that additional payment.
6. Consider Lump-Sum Payments
Got an inheritance, a hefty tax return, or sold some stocks? Use a sizable chunk of any lump-sum amount received to pay off a part of your principal.
Large, one-off payments can drastically reduce the principal. Even if done infrequently, these payments can lead to substantial savings in interest and shorten the duration of your loan.
Whenever you come into unexpected money, instead of upgrading your car or taking that luxurious vacation (tempting, we know!), think of the long-term financial relief that a hefty mortgage payment can bring.
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7. Reevaluate and Cut Unnecessary Expenses
Dive deep into your monthly expenditures and identify where you could cut back.
Freeing up even a tiny amount from your monthly budget can be directed towards the principal. Over time, these additional payments add up and can help shave off years from your mortgage.
Adopt budgeting tools or apps to monitor your spending. Daily gourmet coffee can be reduced to a twice-a-week treat, with the savings directed at the mortgage. Or you could cut back on subscription services you don’t use frequently.
Understanding the mortgage principal is like having a secret key to real estate. It’s more than just numbers. It’s about making intelligent, informed decisions and achieving the dream of homeownership.
Navigating mortgage principals in the ever-changing real estate landscape can be overwhelming. Contact me, Nancy Braun, at 704-286-9844. My team and I at https://showcaserealty.net/ are here to guide and help you. Rest assured, you’re in expert hands with us!
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