Most people buy a house knowing that it’ll take approximately 15 to 30 years to pay off their balance. However, what if you could do this much quicker? Would you take advantage of this timeline?
Prepaying your mortgage can speed your path to debt-free homeownership. But what exactly does this mean, and most importantly, is this the right move for you?
Check your home loan options todayIn this article (Skip to...)
- What does it mean to prepay a mortgage?
- Pros and cons of prepaying a mortgage?
- Ways to prepay your mortgage?
- Factors to consider before prepaying?
- FAQ
What does it mean to prepay a mortgage?
Your mortgage payment includes repayment of both principal and interest.
In the early years of the loan term, a significant percentage of your payment goes toward paying down the mortgage interest, with only a small fraction going to reducing the principal balance.
Explore your home buying options. Start hereThis structure means that during the initial years of homeownership your mortgage principal balance decreases slowly, thus explaining the longer payoff period.
Prepaying your mortgage, however, accelerates the reduction of principal and ultimately pays off your mortgage loan faster.
When you make additional payments toward the principal—which are payments outside your regular schedule—you’re able to chip away at the loan amount owed to your mortgage lender.
Since interest calculations are based on the outstanding principal, reducing this balance sooner means you’ll pay less in interest over the life of the loan.
This shortens the overall length of your mortgage, allowing you to pay off the loan ahead of schedule. And by reducing the principal early, you can save money on interest and build equity (your stake in the home) faster.
Pros and cons of prepaying your mortgage
But reducing the total interest paid over the loan’s life and building equity faster aren’t the only perks of prepaying your mortgage.
Another plus is the peace of mind that comes with cutting down debt.
Check your home loan options todayPaying off your mortgage ahead of schedule can boost financial stability and free up cash for other needs or investments. Plus, owning your home outright is a significant milestone that can ease financial stress.
Prepaying can also gradually reduce your debt-to-income (DTI) ratio and make it easier to qualify for other financing in the future, as well as eliminate private mortgage insurance (PMI) sooner. This can potentially result in a lower monthly payment.
On the flip side, prepaying isn’t a one-size-fits-all solution. It requires extra funds, and if you’re putting more money towards your home loan each month, you might miss out on investment opportunities with potentially higher returns.
For instance, investing in the stock market or a retirement savings account could bring greater benefits.
Keep in mind that some mortgages also come with a prepayment penalty, which could offset any savings gained from paying off your loan early.
Always review your loan terms to see if any penalties apply.
Ways to prepay your mortgage
One common method for prepaying a mortgage is making one extra payment each year. This can be as simple as dividing your payment by 12 and adding that amount to each monthly payment.
For example, if your monthly mortgage payment is $2,000, add $200 to each monthly payment. It might seem like a minor move but this strategy can save thousands over time.
Explore your home buying options. Start hereAnother option is switching to biweekly payments. This involves paying half of your monthly payment every two weeks, resulting in 26 half payments or 13 full payments a year—the equivalent of one extra payment.
You can also make additional principal-only payments whenever you have extra funds, such as a bonus or tax refund. These lump-sum payments can also make a big difference in reducing your mortgage balance.
If you prefer a more structured approach, a mortgage recast might work. This involves making a large payment toward your principal and then your lender recalculating your monthly payments based on the new, lower balance.
This can lower your monthly payments while shortening the loan term.
Factors to consider when prepaying
Before deciding to prepay your mortgage, always consider your current financial situation.
It’s important to have a “fully-funded” emergency fund before allocating extra cash to prepaying your mortgage. This is a minimum of three to six months’ of living expenses. Without a fund, a single unexpected expense like a major car repair or medical bill could force you into credit card debt.
Check your home loan options todayUnlike assets tied up in a home, emergency funds provide liquid cash, offering a measure of security and reducing the likelihood of high-interest debt.
Also, the decision to prepay your mortgage shouldn’t interfere with other goals, such as saving for retirement. So think about your long-term goals and consider how paying off the mortgage fits into them.
If becoming debt-free is a priority, prepaying might make sense.
On the other hand, if growing your investments or maintaining liquidity is more important, you might choose to allocate extra funds elsewhere.
You should also consider other debts that you have. Ideally, high-interest debts like credit cards should be paid off before making extra mortgage payments.
Lastly, compare current interest rates with the potential savings from prepaying. If you have a low-interest mortgage, the financial benefit of prepaying might be less significant compared to other investment opportunities.
The bottom line
Prepaying a mortgage has its benefits, such as saving on interest over the life of the loan, enjoying debt-free homeownership sooner, and building equity faster. But it’s not without drawbacks.
It’s essential to weigh the pros and cons and consider your personal finances and goals. While prepaying a mortgage makes sense for some people, it doesn’t make sense for everyone.
FAQ
Time to make a move? Let us find the right mortgage for youPrepaying a mortgage refers to making additional payments towards your principal loan balance apart from the regular monthly mortgage payments. These extra payments help reduce the overall interest paid and can help you pay off your mortgage faster.
Prepaying a mortgage can have several benefits. It can help you save on interest payments over the life of the loan, reduce the loan term, and build home equity faster. Additionally, paying off your mortgage early provides financial freedom and peace of mind.
It depends on the terms of your mortgage agreement. Some mortgage lenders may charge prepayment penalties, especially if you pay off the mortgage within a certain timeframe. It is essential to review your mortgage contract or speak with your lender to understand any potential penalties.
While prepaying a mortgage offers significant advantages, it’s important to consider potential drawbacks. By prepaying your mortgage, you may be tying up funds that could be used for other investments or financial goals. It’s crucial to evaluate your overall financial situation and priorities before committing to prepaying your mortgage.
The potential savings from prepaying your mortgage depend on several factors, such as your loan balance, interest rate, and the timing and amount of extra payments. Using mortgage calculators or consulting with a financial advisor can help you estimate the potential savings based on your specific circumstances.
Determining whether to prepay your mortgage or invest the extra money elsewhere depends on your financial goals, risk tolerance, and overall financial situation. Consider consulting with a financial advisor who can help analyze your options and guide you in making an informed decision.
The best time to start prepaying your mortgage is typically as early as possible. The earlier you make additional payments, the more interest you will save over the life of the loan. However, it’s important to evaluate your entire financial picture and ensure you have a solid emergency fund and are on track with other financial obligations.
Yes, most mortgage agreements allow you to choose how much extra money you want to pay towards your mortgage. You can make one-time lump sum payments or increase your regular monthly payment amount. It’s essential to check with your lender to understand the process for making extra payments and ensure they are applied correctly to principal reduction.
It’s crucial to keep accurate records of the extra payments you make towards your mortgage. Maintain a separate log, use a mortgage tracking app, or regularly review your mortgage statements to ensure that the additional payments are applied correctly and reflected in your loan balance.