Getting out of mortgage debt faster is a great way to save money on interest payments. For those who make additional payments on their mortgage it can save them money in the long term. A homebuyer can make prepayments on their mortgage principal any time, once a month or once a year, or whenever they want to. The principal is the amount they borrowed to buy the house and have to pay back to the lender. This is separate from the interest, which is what the lender charges you for lending the money. If you pay extra on the principal, it can help pay off your mortgage before the maturity date of the loan.
Prepaying a mortgage isn’t for everyone. The best scenario is for those who plan to live in their home for a long period of time. But if someone plans on selling their home within a few years it is not likely a good idea.
Basically, if you are someone who likes to move around a lot and will be selling your home in the near future, prepayment will not save you as much money as if you will own the home for the long term. If you want to plant yourself in a home for the long-term consider the following tips on how to prepay your mortgage successfully.
Mortgage Prepayment Options
There are few different ways to prepay your mortgage:
- Pay a lump sum to the principal from a bonus or from an inheritance.
- Make an additional payment every year or a total of 13 payments per year.
- Pay a predetermined extra amount on the monthly payment every month.
Quick Tip: When you pay extra on your mortgage, be sure to pay it as a separate check. In the notes section, specify that it should be applied to the principal balance of your loan. This way there is no confusion what amount should go to your principal.
Calculate Your Mortgage Prepayment Plan
You can try different prepayment scenarios by using my Mortgage Payoff Calculator.. Let’s say you have a 30 year mortgage with 25 more years to go. As an example watch what happens when you have $200,000 mortgage at a 4.5 percent interest rate. The mortgage repayment was shortened by 3 years and 9 months if you paid an additional $100 a month. You end up saving $20,806 in interest. Compare the different prepayment options to find what your total savings will be:
|Payment Options||Years to Pay Off Loan||Payment Amount||Total Savings|
|Minimum every month||25 years remaining on a 30 year mortgage loan||$1,013|
|13 payments a year*||21 years, 9 months||$1,013||$17,994|
|$100 extra every month||21 years, 3 months||$1,113||$20,806|
|$50 extra every month||23 years||$1,063||$11,433|
|$25 extra every month||23 years, 11 months||$89,864||$6,016|
*Extra $1,013.37 payment every year
Penalties for Prepaying Your Mortgage
Check your Closing Disclosure (CD) form to see a statement of final loan terms and closing costs. This also should include details on whether your loan allows prepayments or has a prepayment penalty.
There are various types of prepayment penalties. Usually it is a fixed one-time fee. There are some penalties that decrease over time, the longer you wait to pay off the loan. These types of penalties charge a fee based on a set percentage of the total loan cost.
Of course the preferable option is to make sure you get a loan with no prepayment penalty at all!
Look at Prepaying Your Mortgage as an Investment
Prepayment reduces mortgage interest, which is tax-deductible. Ask your CPA or tax professional about how prepaying your mortgage will affect your tax obligation every year.
Is your savings from prepayment more profitable than investing the extra payment into a stock or retirement savings account? Consider the pros and cons of prepaying your mortgage against investing in another property, stock, or insurance option. You might be surprised how the financial calculation works out in your favor. It could be that prepaying your mortgage is not the best way to invest your money.