September 16th, 2020 10:32 AM by Jackie A. Graves, President
When you prepay your mortgage, it means that you make extra payments on your principal loan balance. Paying additional principal on your mortgage can save you thousands of dollars in interest and help you build equity faster.
There are several ways to prepay a mortgage:
How much can I save paying additional principal on a mortgage?
The benefit of paying additional principal on a mortgage isn’t just in reducing the monthly interest expense a tiny bit at a time. It comes from paying down your outstanding loan balance with additional mortgage principal payments, which slashes the total interest you’ll owe over the life of the loan.
Here’s an example of how prepaying saves money and time:
Kaylyn takes out a $120,000 mortgage at a 4.5 percent interest rate. The monthly mortgage principal and interest total of $608.02. Here’s what happens when Kaylyn makes extra mortgage payments:
PAY OFF LOAN IN…
TOTAL INTEREST SAVED
*Extra $608.02 payment
Minimum every month
13 payments a year*
25 years, 9 months
$100 extra every month
22 years, 6 months
$50 extra every month
25 years, 8 months
$25 extra every month
27 years, 8 months
ChangeMyRate.com's mortgage amortization schedule calculator can help you determine the impact of extra payments on your mortgage. Click “Show amortization schedule” to reveal the section that lets you calculate the effect of additional payments.
What are the drawbacks of prepaying my mortgage?
There are potential downsides to prepaying. For starters, tying up your cash in your home means you have less liquidity and wiggle room in your budget. In other words, you’ll have less readily available cash to put toward increasing your 401(k) contributions or paying down high-interest debt, for example. These financial goals could offer a higher return on your investment.
Another consideration is the opportunity cost of not having that extra money invested elsewhere. Over the past four decades, the stock market has returned an average of 10 percent a year. For the broad bond markets, the average annual gain has been close to 8 percent.
When asking yourself, “Can I prepay my mortgage?” look at your entire financial picture. Here are some important questions to consider:
Assessing your financial goals, income and budget can help you decide whether it makes more sense to address other pressing financial concerns before paying ahead on your mortgage.
Do these things before prepaying your mortgage
Prepaying your mortgage is a great goal to work toward but before you do, make sure you’ve met these financial milestones first:
Once those bases are covered, prepaying a mortgage comes down to discipline and comfort level. Do you want to be completely debt-free? Or would you prefer your money to work harder for you in other ways? Ideally, you want to pay off your mortgage before retirement so you don’t have those monthly payments to worry about if your income becomes more limited.
Take a DIY approach to prepay your mortgage
Let’s say you want to budget an extra amount each month to prepay your principal. One tactic is to make one extra mortgage principal and interest payment per year. You could simply make a double payment during the month of your choosing or add one-twelfth of a principal and interest payment to each month’s payment. A year later, you will have made 13 payments.
Make sure you earmark any additional principal payments to go specifically toward your mortgage principal. Lenders typically have this option online or have a process for earmarking checks for principal payments only. Ask your lender for instructions.
If you don’t specify that the extra payments should go toward the mortgage principal, the extra money will go toward your next monthly mortgage payment, which won’t help you achieve your goal of prepaying your mortgage.
Once you have built sufficient equity in your home (at least 20 percent), ask your lender to remove private mortgage insurance or PMI. Paying down your mortgage principal at a faster rate helps eliminate PMI payments more quickly, which also saves you money in the long run.
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