How Much You Can Save Making Extra Mortgage Payments
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. But paying extra on your mortgage isn’t the only way to reach your financial goals, and it might not always be the right move.
Why Pay Extra?
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.
Eliminate debt: 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.
Example: Assume you get a $200,000 30-year fixed-rate loan at 4.1 percent. Your monthly payment is $966.40.
- Interest savings: Over the life of your loan, you pay over $147,000 in interest costs. That’s on top of the $200,000 loan that you have to repay. But if you pay an extra $100 per month, you’d pay roughly $27,000 less in interest.
- Early payoff: By paying an additional $100 per month, you pay off your loan approximately five years early. For the remaining five years, you can redirect that money toward other goals or work less because you don’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.
How to Make Extra Payments
You can send extra money to your mortgage lender in several ways:
Monthly payments: If you prefer to make it a monthly thing, 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 chip away at your loan balance.
Lump sum payments: 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 use money from bonuses or inheritances, and they like the idea of doing something meaningful with that money instead of spending it.
Ask your lender what your options are. Also, find out how to ensure that 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.
Should You Pay Extra?
It’s rarely a bad idea to pay off debt. But sometimes there are better options.
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 you need enough income and sufficient credit scores to get approved. Unfortunately, income might be lacking when you most need the money.
Evaluate your needs, and decide how best to use any extra money you have available.
High-interest-rate debt: If you have other loans with toxic interest rates, it may make more sense to pay off those loans aggressively. For example, credit cards can charge interest rates of 10 percent or more. If your mortgage interest rate is significantly lower (that’s usually the case), you can potentially save more by wiping out other debts first.
15-year mortgages: Another way to slash interest costs and pay off debt sooner is to use a shorter-term mortgage. Although 15-year loans are popular, other options exist. In most cases, with a shorter loan term, you qualify for a lower interest rate. As a result, you pay at a lower rate as well as pay for fewer years.
Build an emergency fund: You have extra money available now, but are you on stable financial ground? Use any funds available to save for a rainy day. It’s wise to keep at least three to six months’ worth of living expenses in a safe place 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 reevaluate and move on to paying 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. With that approach, you can continue paying down your mortgage slowly while simultaneously building wealth.