Is it better to put extra money towards interest or principal?

The Principal Principle: Why Attacking Your Mortgage Head-On Can Save You a Fortune

For homeowners looking to accelerate their mortgage payoff and achieve financial freedom faster, a common question arises: where should I direct my extra money – towards the principal or the interest? While consistently making your regular payments is paramount, the smartest path to a quicker, cheaper mortgage lies in strategically targeting the principal.

Think of your mortgage as a slow-moving mountain of debt. Interest is the cost of climbing that mountain. The principal, on the other hand, is the mountain itself. Paying down the principal is like chiseling away at the mountain’s base. By shrinking the principal, you’re essentially reducing the amount of debt you owe and consequently, the amount of interest you’ll be charged in the future.

Here’s why focusing on principal reduction is the superior strategy:

1. Rapidly Reducing the Outstanding Balance: Every extra dollar you contribute towards the principal directly lowers the total amount you owe. This is a far more impactful strategy than simply paying more towards interest. While interest payments cover the cost of borrowing, they don’t actually reduce the debt itself.

2. Shortening the Loan Term: The most compelling benefit of principal reduction is its ability to dramatically shorten your mortgage term. By consistently making extra payments, you can shave years off your loan, potentially saving yourself tens of thousands of dollars in the process. Imagine being mortgage-free years ahead of schedule – the freedom and peace of mind it offers are invaluable.

3. Significant Long-Term Interest Savings: This is perhaps the most significant advantage. Because you’re consistently reducing the principal balance, you’re also decreasing the amount of interest you accrue over time. With a traditional amortizing mortgage, a large portion of your early payments goes towards interest. By accelerating principal reduction, you shift the balance of payments earlier in the loan’s lifespan, leading to substantial savings over the long haul.

4. Building Equity Faster: Paying down the principal also accelerates the growth of your home equity. This can provide you with more options in the future, such as refinancing for even better terms or accessing a home equity line of credit (HELOC) for other investments or needs.

How to Make It Happen:

• Make Extra Principal Payments: Even small, consistent extra payments designated solely for principal reduction can make a significant difference over time.
• Lump Sum Payments: Consider using bonuses, tax refunds, or other windfalls to make a single large payment directly towards the principal.
• Bi-Weekly Payments: Dividing your monthly mortgage payment in half and paying it every two weeks effectively results in one extra month’s payment per year, significantly reducing the principal.
• Refinance to a Shorter Term: If feasible, consider refinancing your mortgage to a shorter term, such as 15 years. This will inherently accelerate principal reduction.

While tackling your mortgage might seem daunting, strategically focusing your extra money on principal reduction is a powerful tool for accelerating your path to financial freedom. By chipping away at the mountain of debt, you’ll not only shorten your loan term but also save a significant amount of money on interest, ultimately making homeownership a far more rewarding experience. Don’t just pay your mortgage; conquer it!