If you have room in your budget (or a lump sum of cash), making extra mortgage payments may help you in several ways. You can save a substantial amount in interest, and eliminating debt provides flexibility in life.
However, paying extra on your mortgage isn’t the only way to reach your financial goals, and it might not always be the right move. Here's what you need to know before making extra mortgage payments.
- Making extra mortgage payments can reduce interest costs, lower debt, and save thousands of dollars over the life of your loan.
- Make extra payments through lump sum payments or by adding money to your mortgage payment each month.
- Be sure to check with your mortgage lender to see if there's a specific way you need to send extra payments to ensure they are applied to your principal balance.
Why Make Extra Mortgage Payments?
As long as you're honoring your existing mortgage payments, you shouldn't feel obliged to use any extra cash to pay down the mortgage. That said, doing so does offer some significant benefits, and it could ultimately save you money in the long run.
Reduce Interest Costs
Although mortgage loans usually have relatively low-interest rates, the loan balances are significant. Over time, you pay a surprising amount of interest, and most of your interest costs come in the early years of a long-term loan.
In addition to saving money, you buy flexibility when you pay down debt. With your mortgage loan paid off, it’s easier to go into retirement on a fixed income or start a business without worrying about monthly payments. Being debt-free provides the freedom to choose different paths in life.
As an example, assume you get a $200,000 30-year fixed-rate loan at 4.1%. Your monthly payment is $966.40.
- Interest savings: Over the life of your loan, you pay nearly $148,000 in interest costs. That’s in addition to the $200,000 loan (the "principal") that you have to repay. However, if you pay an extra $100 per month, you’d save roughly $28,000 in interest costs.
- Early payoff: By paying an additional $100 per month, you pay off your loan approximately five years early. For those remaining five years, you can redirect that money toward other goals. Or you could choose to work less because you won’t need as much income.
Even if you don’t stay in the same home for 25 years, a 25-year habit of paying extra should bring similar benefits. You’ll spend less on interest and you’ll have more equity for your next home purchase.
To see exactly how much you can save, run detailed calculations for your loan with a loan payoff calculator (see below).
An additional reason to consider making extra mortgage payments is to eliminate Private Mortgage Insurance (PMI) requirements. In general, consumers can cancel PMI if they have made additional payments that reduce the debt obligation to 80% of the original value of the home.
How to Make Extra Payments
You can send extra money to your mortgage lender in several ways. Choosing a strategy mostly comes down to personal preference, but you may find more benefits to one strategy over another.
If you prefer to make it a monthly habit, add a little extra to each monthly payment. You can typically instruct your lender to pull an additional amount electronically, or you can send a check. This approach allows you to fit extra mortgage payments into your monthly budget and steadily chip away at your loan balance.
Whenever you have significant savings in cash, you can put that money toward your mortgage. Some people like to make one additional mortgage payment per year. For example, they copy the amount of their standard monthly payment and make 13 payments per year instead of 12. Others prefer to use a sudden influx of money, such as a bonus or inheritance, to pay down debt instead of spending it frivolously.
Ask your lender what your options are and make sure any additional payments go toward reducing your loan balance. You may need to follow specific steps or provide instructions to your lender.
Most mortgage loans allow for prepayment, whether you add to your monthly payment, make lump sum payments, or pay off the loan entirely. But verify that you won’t cause any problems by paying extra. Ask about prepayment penalties and any other complications that could arise if you try to pay off your loan early.
Other Ideas for Extra Cash
It’s rarely a bad idea to pay off debt, but sometimes there are better options, and sometimes your mortgage isn't your most important debt to reduce.
Extra payments provide the benefits described above, but you lock that money up in your home’s equity. If you need funds at some point, it can be hard to get the money back. You typically need to use a home equity loan, and that approval process requires sufficient income and credit scores. You can't depend on home equity for cash if you suddenly need it.
Evaluate your needs, and decide how best to use any extra money you have available.
If you have other loans with toxic interest rates, it may make more sense to pay off those loans aggressively. For example, the average credit card interest rate is over 20%. If your mortgage interest rate is significantly lower (which is usually the case), you can potentially save more by wiping out those expensive debts first.
Another way to slash interest costs and pay off debt sooner is to use a shorter-term mortgage. Although 30-year loans are popular, other options exist, including 15-year mortgages. In most cases, with a shorter loan term, you qualify for a lower interest rate. As a result, you pay at a lower rate over fewer years.
Build an Emergency Fund
You may have extra money now, but are you on a stable financial footing? Roughly 25% of Americans wouldn't be able to cover an unexpected $400 expense with cash or cash-like payments. If that describes your situation, you might be better off putting extra money toward an emergency fund.
As mentioned above, your home's equity isn't easily or quickly tapped into. It’s wise to keep at least three to six months' worth of living expenses in a safe place, just in case the unexpected happens. If you prefer to be extra cautious, save even more. Doing so allows you to absorb financial surprises without going into debt or making drastic sacrifices. Once you have a healthy emergency fund, you can feel more confident in your decision to pay down the mortgage.
Save for Other Goals
Instead of paying off debt, you may want to make progress on long-term financial goals. If you’re investing for retirement or accumulating funds for education, a steady flow of contributions helps you build up significant assets over time. You may find that it's easier to build wealth by focusing on investments and sticking with a longer timeline for your mortgage payments.