Real estate sales hit a three-decade low last year, making 2024 the slowest market in a generation. I’m proud NOT to be bucketed in the 71% of agents who did not make a single sale. High interest rates and low inventory are a recipe for slow sales; only ~4M homes were sold nationally (for context approx 6.12 million were sold in 2021). One of those variables can be controlled, the other completely out of a prospective buyer’s hands. As a home purchaser myself last year, (at a 6.625% rate nonetheless), I put into practice what’s often cheekily preached about both the market and interest rates; #marrythehomedatetherate. I found a property I loved and “swallowed” the interest to get a forever home.
I, as I also encourage my clients to do, shopped around with lenders to find the best rate. The extra effort saved me almost .5% vs what BofA offered me, $80k+ of savings over the course of my loan! Unless you share the dinner table with Jerome Powell, interest rates are essentially out of everyone’s control and it is unlikely for the Fed to gift us with ~3% interest rates in the foreseeable future. Refinancing is a great option when the numbers make sense but waiting or planning on that is not guaranteed. When purchasing a home, you should ensure that you can comfortably afford the payments, regardless of where interest rates may or may not drop to. There’s never a guarantee that rates will drop enough to justify refinancing—typically, a 1-2% drop is needed for a refinance to make financial sense. Additionally, it can take several years (often 3 or more) to break even on the refinancing costs. It’s also important to note that refinancing resets the clock on your loan term.
One of the most fiscally impactful homeownership hacks outside of refinancing is making extra mortgage payments, which go directly to your principal and the amount you pay in compound interest. By doing so, you shorten the loan term and significantly reduce the interest you pay over the life of the loan. There are a few ways to do this semi-passively which I will expand upon using a $1M loan with a 7% interest rate on a 30-year fixed mortgage.
The Basics: What Are Extra Payments?
When you take out a mortgage, your monthly payment is broken into 4 parts ie your PITI (Principal, Interest, Taxes, Insurance). Principal (the amount you borrowed) and Interest (the cost of borrowing) and your Property Taxes and Insurance (P & I respectively). Early in the loan term, the majority of your payment is amortized and goes directly to the interest to pay the lender back, versus paying off the principal/house. Luckily, extra payments generally go directly toward reducing the principal balance, which in turn can drastically lower the interest that accrues in the future, lowering your “effective” interest rate.
Scenario Overview: $1,000,000 Loan, 7% Interest Rate, 30-Year Loan
• Loan amount: $1,000,000
• Interest rate: 7%
• Monthly payment (principal + interest): $6,653
• Total interest over 30 years (without extra payments): $1,395,614
Let’s examine the impact of extra payments.
Scenario 1: 1 Extra Payment Per Year
If you make 1 extra payment of $6,653 annually (ie bi-monthly payments):
• New Loan Term: 24 years
• Interest Savings: $328,483.68
• Effective Interest Rate: 6.04%
Scenario 2: Two Extra Payments Per Year
If you make two extra payments of $6,653 annually:
• New Loan Term: 20 years
• Interest Savings: $518,441.6
• Effective Interest Rate: 4.42%
By simply committing to two extra payments each year, you cut 10 years off your loan term and save over $500k in interest, dropping your rate to 4.42%.
Scenario 3: Three Extra Monthly Payments Per Year
• New Loan Term: 17.75 years
• Interest Savings: $645,302.21
• Effective Interest Rate: 3.96%
The Benefits of Extra Payments
1. Lower Effective Interest Rate
By reducing the loan term, you effectively decrease the amount of interest paid, which lowers your true cost of borrowing. While the stated interest rate remains 7%, the effective rate you experience is reduced when less interest is paid.
2. Increased Equity Faster
Extra payments reduce your principal faster, giving you more equity in your home sooner. This is particularly beneficial if you plan to sell or refinance.
3. Freedom from Debt Sooner
A shorter loan term gives you financial freedom earlier, freeing up resources for other investments, savings, or retirement.
Key Considerations
• Ensure Payments Go to Principal
When making extra payments, specify that they should be applied to the principal balance, not future payments.
• Verify Prepayment Policies
Some lenders charge prepayment penalties, so confirm the terms of your mortgage before making extra payments.
• Balance Budgeting
While extra payments offer significant benefits, ensure they align with your overall financial goals and budget. Tax refunds, bonuses, or other windfalls are a great way to make a lump sum payment towards your mortgage. Another simple option is to round up your monthly payment to the nearest hundred (or more if you can afford it).
A Strategic Move for Long-Term Savings
Making extra payments on your mortgage is one of the most straightforward ways to save tens—or even hundreds—of thousands of dollars while gaining financial freedom sooner. Whether you opt for biannual extra payments and/or a specific amount allocated per month or year the long-term benefits are substantial. For homeowners with a $1M property at a 7% interest rate, these small sacrifices can lead to massive savings and a brighter financial future.
How to get a ~4.5% rate without refinancing.
- Set up your payments to be paid bi-monthly. There are 52 weeks in a year, meaning you’ll make 26 half-payments (13 full payments) instead of 12 monthly payments.
- Make those bi-monthly payments equal to 1/26th of one monthly payment ($6653); an extra $255.88/every 2 weeks. This is equal to making 2 extra annual payments thus shaving 10+ years off your loan!
This is a lot to digest. My $.02 is to play with ChatGPT or any of the online early payment calculators using your specific mortgage scenario, you can even set your desired interest rate and this calculator will tell you what your extra payment needs to be :) If you’re considering this strategy or want to learn more about how to optimize your mortgage, your lender should be available to develop a plan tailored to your financial goals and real estate journey.