Interest is like growth serum sprinkled over money: a small percentage compounding over time until the result isn't small at all. Like a stream that becomes a river and gradually erodes the land to carve out a gorge, interest merely needs time to accomplish big things.

Most people get the concept of interest, but many are surprised when they see actual dollar amounts attached.

You know who understands interest well? Banks. The banks promote low interest rates knowing that while the low rates are certainly better for borrowers than high rates, the bank will still make plenty back. They merely need to refer to the loan's amortization table.

Even more surprising than seeing real dollar amounts attached to interest is seeing the effect of paying an extra $100 toward a loan's principal. Let's look at the surprising savings of paying $100 extra each month.

Mortgage Prepayment Results

How would you like to save about $20,000 on a $250,000 loan? Oh, and own the home outright four years sooner too? That's the effect of paying $100 extra every month. The key is the extra money must go entirely toward the principal; that is, the home. Lowering the principal as soon as you can is your only hope of turning the table in your favor—the amortization table, that is.

What's amortization?

Amortizing is a way for lenders to front-load the length of the loan with interest so they get paid first. For example, pretend your payment is $1,000. A loan might carry an interest rate of 4%, but that doesn't mean $40 of your $1,000 payment goes toward interest and $960 goes toward buying the home. Amortization makes it so that about $700 of your payment goes toward interest and $300 toward the principal. Next month the ratio might be $698 and $302, then $696 and $304 a month after that. You could be 10 years into a 30-year fixed-rate mortgage before the ratio flips and more of your payment goes toward the home than to repay the bank. Eventually, at the end of the term, most of your payment actually buys the house.

Plug an extra $100 principal payment into an amortization table, however, and behold the savings!

$250,000 Home Loan

Monthly payment $1,068; 3.10% fixed APR. What happens when you pay a little extra toward the principal each month?


$250,000 mortgage at 3.10% APR; Monthly payment $1,068
Paying Loan Paid In… Total Interest Total Int. Saved
Minimum every month 30 yrs $134,315 $0
$100 extra a month 26 yrs $114,539 $19,776
$75 extra a month 27 yrs $118,894 $15,421
$50 extra a month 28 yrs $123,608 $10,707

Surprising results, right? For an extra $100 a month, you have shaved four years off the mortgage and kept nearly $20,000 in your own pocket instead of stuffing it in the bank's pocket. If you can't swing an extra $100, then look at the still-substantial savings from just $50.

Be sure all the extra payment goes toward the loan principal.

However much extra money you pay each month, ask your lender how you can to ensure that the extra goes entirely toward the loan principal. That's the only way "the $100 trick" works, by upturning the usual ratio on the amortization table. Examine your monthly statements to make sure 100% of the extra payment went toward the principal, not the interest. Don't let the bank divert any of that money to its own pockets.

Paying down the principal sooner dramatically cuts the amount of interest you pay over the life of the loan.

Now that we have stressed the importance of your extra payment going toward principal only, let's look at more real-dollar examples for 30-year fixed-rate loans.

$300,000 Home Loan

Monthly payment $1,281; 3.10% APR.


$300,000 mortgage at 3.10% APR; Monthly payment $1,281
Paying Loan Paid In… Total Interest Total Int. Saved
Minimum every month 30 yrs $161,178 $0
$100 extra a month 26 yrs 9 mos $140,885 $20,293
$75 extra a month 27 yrs 5 mos $145,444 $15,734
$50 extra a month 28 yrs 3 mos $150,321 $10,857

According to recent data from Realtor.com, the average home price in America shot up to $349,000 last summer, an all-time high. So let's look at the savings for that level of home loan.

$350,000 Home Loan

Monthly payment $1,495; 3.10% APR.


$350,000 mortgage at 3.10% APR; Monthly payment $1,495
Paying Loan Paid In… Total Interest Total Int. Saved
Minimum every month 30 yrs $188,041 $0
$100 extra a month 27 yrs $167,362 $20,293
$75 extra a month 27 yrs 9 mos $172,075 $15,966
$50 extra a month 28 yrs 6 mos $177,074 $10,967

Caution
The majority of mortgage loans allow you to pay extra on the principal, but a few don't. Read the terms of your loan or talk with your lender to be sure there would be no penalty for prepayment.

Conclusion

Seeing actual dollars attached to interest rates is definitely eye-opening. Few people would expect that borrowing $350,000 at a 3.10% interest rate, as low as that rate is, still means paying $188,041 to the bank. How did 3.10% become more than half the amount I borrowed? people wonder. It's like I'm buying half the house all over again! That's the shocking effect of interest over time.

Home ownership is the reward, of course. And when you use the $100 trick to pay more on the home and less to the bank, you reach full ownership all the sooner. Connect with a lender who offers you your best options today.