What is the best way to repay a 30 year home loan?

One of the most common loan terms that buyers usually leverage when purchasing a home is by paying a 20% downpayment and leveraging 80% of the sale price as loan amount. As of this article writing, a 30-year mortgage rates is hovering around 6.5% for a 30-year loan term. And if you are one of those lucky buyers who bought a house during the COVID era, the interest rate would have been much lower......

I wanted to show you various options of repayment methods and which options gives the most benefit of lowering the repayment tenure thereby providing significant savings on the potential interest paid.

For the calculations in this article, we have 2 different buyers purchasing a home with a sale price of $675K with a 20% downpayment and 30 year loan term. However, one of them bought with an interest rate of 6.5% and the other with an interest rate of 3.5%. Lets see how the interest paid varies over time with different modes of repayment.

Here are the 4 methods of repayment that each buyer choose to pay -

1. Monthly

2. Monthly with additional $10K at the end of each year.

3. Bi-weekly

4. Bi-weekly with additional $10K at the end of each year.

   
   

For a moment pause here. Can you rank the order of the payment modes that helps reduce the loan term and save interest the most?

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OK.... now lets get into the details of how much can we save from each of these payments modes.

Below table shows the total interest paid over 30 years with a 6.5% interest rate. Note how the interest can be reduced by almost 47% from the total interest owned by paying an additional $10K every year until the loan is paid off.

Payment option	Interest Paid over 30 years	Interest Savings rel to Monthly payment	Interest saved %
Monthly - 6.5%	$645,693.97
Monthly - 6.5% + 10K	$339,906.03	$305,787.95	47%
Bi Weekly - 6.5%	$496,916.84	$148,777.13	23%
Bi Weekly - 6.5% + 10K	$297,650.31	$348,043.67	54%

Below table shows the total interest paid over 30 years with a 3.5%. Note how the interest can be reduced by almost 42% from the total interest owned by paying an additional $10K every year until the loan is paid off.

Payment option	Interest Paid over 30 years	Interest Savings rel to Monthly payment	Interest saved %
Monthly - 3.5%	$312,133.94
Monthly - 3.5% + 10K	$179,822.44	$132,311.51	42%
Bi Weekly - 3.5%	$267,209.45	$44,924.49	14%
Bi Weekly - 3.5% + 10K	$164,269.75	$147,864.19	47%

Lets look at how the interest paid and the tenure changes over the 30 year period in these scenarios. As you can see from the below chart, the bold lines are the 4 different payment options at 6.5% interest rate and the dotted lines are the 4 different payment options at 3.5%.

Cum interest paid over 30 years with 6.5% interest and 3.5% interest with / without Annual additional amount.

Here are the 3 main observations from the chart above -

1. Irrespective of the payment option, the innterest paid us almost 2X times for a loan with 6.5% interest over a loan with 3.5%

2. By paying a lumpsum amount atleast once a year (in our example $10K / year) provides significant savings and reduces the loan term significantly.

3. When the interest rates are higher, it helps lower the interest amount paid and the tenure by choosing any of the payment options -

   1. pay a lumpsum amount (once a year)

   2. increase the frequency of payment (biweekly)

   3. pay additional amount (every payment)

      
      

If you are wondering how the interest paid and the tenure reduced, with each of these payment options, it is mainly because each of these additional payments reduces the outstanding loan balance. Below chart shows how much outstanding loan balance is paid over the loan term..... It is clear that by paying additional lumpsum amount (in this example, it is around $10K / year) the loan tenure was reduced by almost half the number of years required to pay the loan.

Loan repayment paid over 30 years with 6.5% interest and 3.5% interest with / without Annual additional amount.

Here are the 2 main observations from the chart above -

1. Unlike the interest paid over time charts, interest rate does not have any significant impact on the loan repayment amount (for instance, the solid line and dotted line are relatively close to each other unlike the charts showing the interest paid).

2. By paying a lumpsum amount atleast once a year (in our example it is $10K / year) reduces the loan term significantly (irrespective of the interest offered) over paying monthly or bi-weekly.

Action : So to summarize, if you are the one who is paying higher interest rate (atleast 6% or more), it might be worth exploring the options of choosing one of the 4 payment  options (ranked in the order of maximum savings) to save on the interest and reduce the loan term.

1. Biweekly + Lumpsum Additional Amount

2. Monthly + Lumpsum additional amount

3. Biweekly

4. Monthly