How to Accelerate Your Mortgage Payoff

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Should you get a thirty year or a fifteen year loan?

There have been many questions recently on the BiggerPockets Forums about whether to get a thirty year or a fifteen year loan and why.

I always recommend investors, especially when just starting out, get a thirty year mortgage when financing through a traditional lender. The longer loan period gives more cash flow and cash flow, essential at all times, is especially vital when you’re new to the business. No matter how much money you have saved or how much profit you make off your properties, this is a very expensive business and it doesn’t take long to go through any amount of money you have.

And, with a longer term loan, you always have the option to pay it off sooner. Ten years down the road, accelerated payoff should be much easier to consider than it is in year one. In the beginning, keep all the money you can to purchase as many performing properties as possible; pay down debt later when you have built your kingdom!

Any time you recognize that you have excess cash just sitting around doing nothing, you can start paying off mortgages. Here’s how.

Easy steps to accelerate your loan payoff:

  1. Pull up your online amortization schedule.
  2. Write a check for the full amount of your current payment.
  3. With that payment, send an additional check for as many additional principal payments as you plan to pay. Attach to that second check a note saying something like: “Enclosed please find a check for payment number six (for this example, we’ll say your next payment is payment number six). Also, an additional check for the principal amount for payments number 7, 8, 9, and 10.”
  4. The next month, you will send in payment number eleven.

You cannot skip payments for the next 4 months!

You may never skip a payment. You must make another full payment the next month (month seven in our example), but it will now be payment number eleven. You just saved all the interest on payments 7, 8, 9, and 10.

Real life example:

When our youngest son and his bride purchased their first home, naturally we wanted to get them something wonderful for the momentous occasion. They had been married just over a year and were moving from their apartment which was well furnished. Turns out, there was really nothing new that they needed for their condo. So, we did something which turned out to also be a great life lesson for them. We paid their first year’s mortgage.

As you can understand from the explanation above, it was very easy and relatively inexpensive to do. The first year, after all, has the least amount of principal payment but is very high in interest. My son made the first full payment, we made the next eleven by simply adding up the principal amounts and sending in a second check along with his check for payment number one. We attached a letter to the second check which stated basically, “this check is for the principal payments number 2, 3, 4, 5, 6, 7, 8, 9, 10, 11 and 12. My son checked the online amortization schedule before making his next scheduled payment to confirm that all of our payments had been applied as directed. They had been, and he now owed the full amount for payment number thirteen. (The updated amortization schedule may show this next payment as the new number “two” payment rather than payment number “thirteen.” The amount left owing is what you want to confirm rather than the number of the next payment.) The payments had been applied correctly, meaning our son and his wife had just saved all of the interest they would have paid during year number one.

Easy! And exciting to watch the basically painless accelerated pay down.

Do you need to enclose the letter of explanation?

I’ve asked lenders if the letter that we send with our additional principal payments is necessary. It is. Without a letter of direction, the extra funds will simply be applied by them to another payment which will include the interest amount. You want to be sure that the entire amount is applied to principal ONLY, so best to write a letter everytime you send in extra payments explaining to the bank that the extra funds are to be applied only to principal. The whole point is not only to pay down your mortgage faster, but to pay it down cheaper, avoiding any unnecessary interest payments.

Note: when negotiating for a loan, always request no penalty for early payoff.

Did I explain this clearly? Have you ever done an accelerated payoff? What tips can you add?

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About Author

Karen Rittenhouse has been investing in real estate full time since January 2005. In that time, she has purchased hundreds of single family properties, opened a full-service real estate company, a property management company, a coaching/training business, and written three books on real estate.

41 Comments

  1. What is the difference, or is it the same thing as just making a payment to the principal ?
    I really don’t understand what you were saying?
    thanks
    Lynn

    • karen rittenhouse

      Hi Lynn:

      It is making payments to the principal. These are the steps you should follow rather than just sending a check for more than you owe so that you can be sure your extra payments are applied correctly.

  2. I have heard of this practice before, but like Lynn, I would like to know what’s the difference if we just send in an additional principal payment?

    • karen rittenhouse

      Hi Lorene:
      This extra step of adding a letter is precautionary so that the payment goes toward the next monies owed which will save you the most interest rather than the bank simply applying it to the end of the loan which saves you nothing. Have you looked at your amortization schedule to see how the monthly interest payment is so high at the beginning of the loan and decreases toward the end of the loan?

  3. Steve Toohey on

    Karen, I’m not sure I follow either. I have made additional principal payments for a round number, not the specific amount of principal of the next payment due. Why is specifying the payment number an issue if it comes off the principal, and there are no prepayment penalties?

    • karen rittenhouse

      Hi Steve:

      Like I mentioned in the post, oftentimes, extra payments are applied to the end of the loan where there is no interest anyway. You want to make sure extra payments are applied to the next loan payment where you’ll be saving the most interest.

      • Steve Toohey on

        I still don’t follow the end of loan issue. Isn’t principal the same regardless of “where” its is on the table? Doesn’t any additional principal payment cause the entire amortization to be modified, because interest paid is now based on a lower principal amount?

  4. This got me worried as I always take all my extra cash flow and put it into paying off one loan at a time. This made me think my extra principle pay down was going to back end payments, but I just checked and all my extra principle is going to front end payments and I am fine.

    I don’t think there is a difference between what was explained in the article and just adding extra principle, at least in my case.

  5. “We have heard, however, where additional payments have been applied to the back of the loan, the payments that are all principal with little to no interest due… Rather than taking a chance of our payment going to the back of the loan…”

    Why would you want to have your payment applied to interest instead of to principal? Since the interest is tax deductible, and if you refinance you would have more of the principal paid down, I don’t understand why it would ever be beneficial to apply payments to the front end vs. the back end? In the extreme, if you paid enough of an extra payment to totally cover the principal amount, you would have the entire loan paid off (applied to the back end), vs. just covering the interest (applied to the front end).

  6. karen rittenhouse

    Hi Ethan:
    No, we DON’T want the payment to go to interest. We want it to go to ONLY principal. That is why the need for clarification to the bank. If you send in additional money and the bank applies it to the end of the loan, it is not saving you any interest as there is no more interest left by the end of the loan. When you send in an additional payment, you want to be sure it is applied to the next payment due where the most interest would be saved. If, for example, your extra payment goes toward a $1000 payment where $500 is principal and $500 is interest, you can send in $500 to cover the principal and not owe the $500 interest because you paid early. That means a savings to you of $500. If you apply it to the final payment, there is no interest left owing so no savings to you.

    And, you’re absolutely right, if you send in the entire payoff amount, you would save all of the interest still due on the loan at that time. That would be sweet!

  7. Thank you, Karen, I think I understand – if you direct them to apply the payment to the next upcoming principal payment there is no misunderstanding as to where to apply it (backend or front). However, just one more clarifying question – if I send in just a lump sum with instructions to apply towards the principal wouldn’t that be the same, wouldn’t it just go to the actual overall principal? And won’t the interest saved still be the same?

    When I heard about this before, I wondered the same thing but I didn’t really get how it was different, if you gave specific instructions to put towards principal either way.

    • Lorene,
      I think you are correct. I’m pretty sure that extra money sent in can only be applied to your principal balance. I’m not sure what else it could be, unless you direct the bank that the payments are to be used for future payments. I’m sure that where payments are directed absent additional instructions is spelled out in the Note.

  8. Steve Babiak on

    The extra payments reduce the principal balance at the time received by the lender – period. Nothing to do with this stuff about “end of loan”. Then the remaining payments have to have their interest and principal amounts re-computed based on the new principal balance. Effectively, by including the exact amount of principal for months 2 through 12, it seems logical to guess that the interest due in the next installment would be the amount from the payment that would have originally been payment number 13.

    So I agree with the others who just allocate the amounts over the payment due to additional principal. If you get a mortgage payment coupon, there might even be a line on the coupon where you can place the amount that you are applying to additional principal or escrow.

      • karen rittenhouse

        Hi Steve and Steve:
        I so appreciate all the comments and feedback. Because of all these comments, I have a call into a banker friend to see if things have changed. So much has changed in recent years with banking, including credit card payments and disclosures.

        Here’s another way to say what I used to know as true. Suppose your rent is $1200 per month. That payment is principal plus interest. In the past, if you mailed in $2400 with $1200 for your current payment plus an additional $1200, that additional went to another principal plus interest payment unless you sent in direction making sure the $1200 went to principal only.

        Because of all this current response, my thinking is that banking regulations could have changed since we were first told that the process I described in the post was necessary. Perhaps today any extra money is required to go only toward principal? Do you know this to be true? If so, hooray for banking and sending in additional payments is much easier than it used to be. Certainly possible which is why I left a message with one of our lenders.

        Thank you for taking the time to comment, and possibly updating an dinosaur!

  9. With current interest rates, a better gift would be to give them the cash with the understanding that it be used toward their first rental property purchase. :-)

  10. Years ago, I sent in extra payments on a car loan. The bank just assumed I was making future payments, and simply kept slipping my next due date out. When I saw a six month gap, I called them up and insisted they recompute and apply towards principal. Ever since, I make sure to flag extra as “apply towards principal.” That seemed to do the trick.

    • karen rittenhouse

      Great info. From what I understand, extra mortgage payments can also end up in escrow or just being held as if they don’t know what to do with the payment.

      Letters of direction are always a good idea.

      Thanks, Greg, for the comment.

  11. Ok, I checked with a local lending institution and here’s what I was told:

    You definitely need a letter of direction. If you send in an additional payment check or simply a check that is larger than the amount currently owed, that extra money can be, and most often is, applied as an additional payment which includes interest as well as the principal.

    What you want to stress to the bank is that the additional monies are for “principal payments only.”

    The point is to save yourself as much of the interest as you can. Naturally, the earlier in the loan that you do this, the more interest you save because, once you have made a payment, a percentage of that payment is applied to the interest and that is money you will not get back. Earlier in your loan, MOST of the payment is interest. Yes, we can still claim interest deductions on our taxes, but far better to not pay the interest in the first place.

    Extra principal payments come off the balance due and there is no need to worry about including beginning or end of the loan. A direction letter is necessary so that your “additional” payment does not go to pay any interest, but principal only.

    Thanks, guys, for all of your concerns and comments to help clarify the meaning and understanding of my post.

    • That is what the banks prefer to do – apply the extra toward a payment. But as I said above, that you just need to apply the extra toward additional principal, and it comes off the principal balance owed. And perhaps I was not clear that you do have to tell them that this extra amount is supposed to go toward principal; otherwise, it might be applied as the bank sees fit – like toward additional escrow, or toward an escrow shortfall, or toward the next payment due.

    • Karen, thank you for going the extra step to get clarification from the lenders! This clears up all misunderstanding and makes your point clear as well. Thank you again for the great article! :)

  12. I think I understand what you mean but it’s hard to visualize. Could you do a follow-up post on this same subject, but actually throw in a hypothetical loan so we can see, visually, how it changes?

    That is, do a sample amortization calculation and post the first 10 years of the 30 (to keep it short). Then show exactly how much and where we would apply extra payments and then post the updated amortization schedule for those same 10 years so we can see exactly what we would save. I think that would help me, and others, who are still a little bit confused. Thanks!

  13. I’m paying off $177,650 in 3.5 years by accelerating the payoff of the first mortgage and then snowballing the new monies to the next mortgage.

    One of my first large payments toward principal for $10,000 was partially applied as a regular payment by the bank. A quick phone call to the customer service dept corrected the issue so that is became a principle-only payment.

    Now I’m blogging and updating on my monthly progress.

    • Congratulations, Curtis! So few people do this but, boy, does it work!

      And how easily what we send in becomes a regular payment by the bank. Thanks for sharing that your phone call converted that to principal only.

      Keep us posted on your success!

  14. Great post Karen – Thank you – This is one of those things I have been meaning to look into for a while now and this realy explained it well in simple terms and has motivated me to get off my rear and do it!

    Thanks again

    Lorcan

  15. Hey Karen,

    Like a lot of people the whole letter thing and saying apply the funds to the principle of payment number blah blah is a little hard to wrap my head around.

    Do your loans not have payment coupons?
    All of my institutional loans come with a coupon (and the online forms are the same format) where it gives the payment due amount (Then always an * and the >15 day late payment) then a line for additional escrow (Anyone have a reason why you would ever pay additional escrow?) and then a line for additional principle. As long as you put whatever extra you are sending in on that line I don’t see any reason to think it won’t be done right.

    Like others I did take the time to log into some online accounts to see the pay-down on the principle for my last few payments and the balance has been reduced as expected.

    I do fully agree you can’t just assume that the bank will apply funds as you want. The worst thing someone could do is follow some of the general financial advice of making an extra payment once a year, if you don’t give instructions. If you just send in 2 checks for the exact payment amount and no clarification then I’ll guess 99 out of 100 times the bank will just credit it to your next regular payment (and likely being generous with the 1% doing it correctly).

  16. Hi Shaun:
    Glad your payments are being applied as expected.

    Not everyone does “get it” like you do. I list the numbers because it helps many get the visual of what they’re actually doing when they see it.

    Thanks for taking the time to comment!

  17. Karen, Thanks for this article. We bank online and made sure to confirm that those extra payments we’d been sending were going to principle. Whew! They were. I hadn’t considered it as I went along, but sure am glad to look.

    I am curious, though, at what stage in your business did you start paying off mortgages?

    • Hi Kerry:
      We have paid off, and then borrowed against, properties for the past 3-4 years. We are now, after 8 years of buying full time, just flipping and wholesaling to pay off what we have because we finally feel that we have enough!

      Thanks for asking. Wishing you tremendous investing success!

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