Would You Drop Cable for $40,000?

When my wife and I paid off over $100,000 in student loans in four years we didn’t do it simply because it felt good or for some moral purpose. When we paid that debt off we saved ourselves thousands of dollars in interest. That’s not noble, it’s self-serving. Today we’re going to look at what happens when you spend just a few more dollars each month on your mortgage (hint: you get rich faster!). Let’s go…

What’s a mortgage?

For most Americans the path to home ownership is our primary source of building wealth. To get there most of us finance our home purchase using a bank. The loans we take out to do this are called “mortgages.” There are typically two types.

Adjustable Rate Mortgages

An adjustable rate mortgage charges you a low interest rate for the first few years of your mortgage, then adjusts it (almost always upwards). These types of rates are often provided to at-risk borrowers with a low teaser rate that’s perfectly affordable and then jack up your monthly payment later if you don’t refinance. Keep in mind your ability to refinance to a fixed rate loan isn’t always up to you.

I recommend avoiding an adjustable rate mortgage at all costs.

Fixed Rate Mortgages

A fixed rate mortgage is the more traditional variety of mortgage you’re likely familiar with. You borrow a specific sum of money at a fixed rate of interest to be paid back over a certain number of years. So for example, you might borrow $100,000 at a rate of 5% interest that you pay back over 30 years. The most common ranges of time for a fixed rate mortgage are either 15 or 30 years.

A test case

So how long does it take you to pay back a mortgage, and how much are you paying towards the amount you owe (principal) versus the amount you’re paying the bank to borrow the money in the first place (interest)? Let’s look at a test case.

Ryan wants to buy a house. He has $50,000 saved for a down payment. Using a standard 20% rate for down payments he decides to purchase a house that costs $250,000. Providing $50,000 of his own he’ll need to borrow $200,000 from the bank. For the sake of our example, Ryan has fully funded his emergency fund so he’s got cash in case he needs to pay surprise closing expenses or things of that nature; the $250,000 house price is the only money we’ll need to worry about him spending.

He gets approved by his local credit union for the loan. The terms are as follows:

• 30 year repayment plan
• 5% interest rate
• $200,000 total borrowed

So how much is Ryan spending on his interest each month with his loan? Let’s take a look at the first year he spends paying off his mortgage.

DATE	PAYMENT	PRINCIPAL	INTEREST	TOTAL INTEREST	BALANCE
Apr-16	$1,073.64	$240.31	$833.33	$833.33	$199,759.69
May-16	$1,073.64	$241.31	$832.33	$1,665.67	$199,518.38
Jun-16	$1,073.64	$242.32	$831.33	$2,496.99	$199,276.06
Jul-16	$1,073.64	$243.33	$830.32	$3,327.31	$199,032.74
Aug-16	$1,073.64	$244.34	$829.30	$4,156.61	$198,788.40
Sep-16	$1,073.64	$245.36	$828.28	$4,984.90	$198,543.04
Oct-16	$1,073.64	$246.38	$827.26	$5,812.16	$198,296.66
Nov-16	$1,073.64	$247.41	$826.24	$6,638.40	$198,049.25
Dec-16	$1,073.64	$248.44	$825.21	$7,463.60	$197,800.81
Jan-17	$1,073.64	$249.47	$824.17	$8,287.77	$197,551.34
Feb-17	$1,073.64	$250.51	$823.13	$9,110.90	$197,300.83
Mar-17	$1,073.64	$251.56	$822.09	$9,932.99	$197,049.27

As you can see, in the first year Ryan primarily spends money on paying the bank for lending money to him in the first place. While he pays them nearly $10,000 in interest, he pays less than $3,000 on the principal. That means he builds hardly any equity; most of his mortgage pays for the privilege of having been lent the money in the first place. In fact, this is true for much of the duration of the loan. At a 30 year repayment rate Ryan is looking at paying off his house in March of 2046. The first month he’ll pay more to the principal than he will to interest is June in the year 2032 ($538.39 versus $535.25). That’s not for well over a decade! Up until then most of his money is going to his bank.

So just how much interest does Ryan pay in exchange for the loan to buy his house? By sticking with the standard repayment plan he’ll pay the $200,000 he owes plus an additional $186,511.57 in interest.

If Ryan sticks with the standard 30 year repayment plan, he will pay almost double the $200,000 he borrowed to buy his home!

That’s no joke! To buy his house he’ll need to pay nearly 2x its value when he purchases it! That’s crazy! He’ll also be in debt for 30 years working to pay off the house, very slowly accruing equity in the home. There’s got to be a better way.

A second test case

Let’s imagine for a moment a different Ryan. Well, the same Ryan from our first test case but this one is a regular reader of the Bill Stark blog. He happened to read about 5 things he spends too much money on and after buying his home he decides to cut one of those expenses: cable television. He loved watching Game of Thrones and reruns of Law & Order on TBS but decided the $100 he spent on that luxury just wasn’t worth it. After all, now he spends more of his free time taking care of the house he just purchased.

So what should Ryan do with that extra $100 he has sitting around each month? He spends it on lottery tickets.

Wait, no, he spends it on his mortgage. He throws the extra money into his mortgage payment each month taking his total monthly payment from $1,073.64/month to $1,173.64. Here’s how that impacts his repayment over the first year.

DATE	PAYMENT	PRINCIPAL	INTEREST	TOTAL INTEREST	BALANCE
Apr-16	$1,173.64	$340.31	$833.33	$833.33	$199,659.69
May-16	$1,173.64	$341.73	$831.92	$1,665.25	$199,317.96
Jun-16	$1,173.64	$343.15	$830.49	$2,495.74	$198,974.81
Jul-16	$1,173.64	$344.58	$829.06	$3,324.80	$198,630.23
Aug-16	$1,173.64	$346.02	$827.63	$4,152.43	$198,284.21
Sep-16	$1,173.64	$347.46	$826.18	$4,978.61	$197,936.75
Oct-16	$1,173.64	$348.91	$824.74	$5,803.35	$197,587.85
Nov-16	$1,173.64	$350.36	$823.28	$6,626.63	$197,237.49
Dec-16	$1,173.64	$351.82	$821.82	$7,448.45	$196,885.66
Jan-17	$1,173.64	$353.29	$820.36	$8,268.81	$196,532.38
Feb-17	$1,173.64	$354.76	$818.88	$9,087.70	$196,177.62
Mar-17	$1,173.64	$356.24	$817.41	$9,905.10	$195,821.38

He still pays about $10,000 in interest to the bank. But instead of the not-quite-$3,000 in principal he paid off in the first example he’s now managed to pay off closer to $4,200. That’s nearly 50% more principal paid off than if he hadn’t canceled cable! And that $1,200 makes sense: each month he puts $100 extra towards the loan which is directly applied to interest.

There’s another interesting piece of savings Ryan walks away with when he approaches the plan with this method. By paying off more of the principal each month he’s cutting into the amount the bank uses to determine how much interest he owes. As that amount gets smaller the amount of interest he pays decreases as well. For the first year that netted him a savings of $27 in interest. That doesn’t seem like much, but take a look at what happens when Ryan pays that $100 extra for the entire life of his loan.

By paying just $100 month, Ryan saves himself $37,069.03 in interest payments.

That’s an amount in the neighborhood of what Ryan spent as his down payment. Hell, $40,000 is probably enough to hire Peter Dinklage and Mariska Hargitay to personally visit his house and drink champagne with him while he basks in the glory of no longer being in debt and actually owning his home! That would more than make up for all those years he opted to forgo cable.

Other cool things Ryan gets for spending just $100 more towards his mortgage each month? He starts paying off more of his principal than interest in April of 2027 ($589.17 versus $584.47), five years sooner than the previous plan. He also actually owns his home in January of 2041, also five years sooner than on a traditional 30-year payment plan. The benefits of cutting his cable and putting just $100 extra towards his home loan are extraordinary for Ryan!

If someone offered you $40,000, would you give up cable?

If you have a home mortgage, there is someone willing to offer you this deal: your bank!

Let’s go deeper

What if Ryan starts putting even more money towards his mortgage each month? How does that impact his repayment strategy? Let’s take a look at extending our previous chart to consider situations in which Ryan can afford $200, $300, $400, and $500 more on his mortgage each month.

Pretty crazy savings! In fact, with the $500 plan Ryan pays just $85,390.30 in interest on his loan. That’s less than half of the amount he would pay under a traditional 30 year model! That is a crazy amount of savings, plus he owns his home much more quickly. How quickly? A decade and a half as he finally becomes a true home owner in May of 2031 instead of March of 2046 as originally planned.

What this means for you

Not all of us have $500 to put towards our mortgage each month on top of our regular expenses. However, if we utilize the most powerful financial tool in the world and find some things to cut we can work to find ourselves in a position where just $100 extra each month could be worth as much as $40,000 in interest payment savings. And that’s nothing to scoff at!

How can you get to the savings to throw some extra cash at your mortgage payment each month? Come up with a solution, share it in the comments to help your fellow readers, and I’ll work on getting Peter Dinklage and Mariska Hargitay’s agents’ phone numbers (you’ll have to provide your own champagne).

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