Have you considered the benefits of paying your mortgage off sooner? One popular reason people choose to do this is to save thousands of dollars in interest over the life of the loan. However, paying your loan off early is not always the best option for everyone.
Increasingly popular programs like the FIRE Movement encourage young adults and seniors alike to pay off debt, pursue financial independence, and achieve early retirement. But, no matter what your motivation is, there are some crucial details to consider before making the decision to pay your mortgage off months or years early.
Should You Make Extra Mortgage Payments?
A great place to start is to weigh the pros and cons of this topic. That way, you'll be able to make an informed decision. So let's explore the following scenarios to determine what factors you should consider when considering whether or not to pay your mortgage off early.
Pros:
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You could save on interest fees over the life of your loan by paying down more of your principal loan balance. Putting more money towards the principal balance will help you pay less in interest over the life of the loan and will shave time off of your term so you can pay it off sooner. Adding just one extra payment a month will help you be mortgage-free sooner and save you potentially thousands in interest.
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Eliminate your monthly mortgage payment and enjoy the additional cash flow. No longer having a mortgage payment means you can now use those funds to invest. Depending on conditions in the housing market, a smart move is to invest in real estate to rent out with the idea of earning long-term returns on your investment. If you've crunched the numbers and feel confident that you can swing paying extra each month or through lump-sum payments, then paying off your mortgage early can be a great way to increase your liquidity and protect yourself from inflation.
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You'll own your home, free and clear! With your house paid off, you can achieve financial freedom. Perhaps your goal is to pay your mortgage off before retirement. You'll enjoy a more comfortable budget during retirement without mortgage payments looming over you. And with more funds freed up each month, you could travel more, save more, or even invest more.
Cons:
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If you pay the loan off early, prepayment fees could be levied against you. To avoid this, we advise that you check with your lender and make sure they won't penalize you for paying the loan off earlier than the years of the term. Many loan types have been prohibited from charging prepayment penalties by the federal government. While these kinds of penalties are rare and capped at 2% within the first two years, it's still worth your while to investigate before making a decision.
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You could potentially impact your credit negatively by paying your loan off early. Keeping the loan open for the entirety of the term goes a long way in maintaining your credit score history. In fact, debts like a mortgage are what help you improve your credit score and financial stability.
Additionally, paying off high-interest credit card debt will improve your credit score and debt-to-income ratio. When closing out an account like a mortgage loan, your credit history might temporarily drop. But as long as you maintain good credit habits, you can get that score back up in no time.
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One possible outcome of paying your mortgage off early is that you could put yourself at risk of losing your liquidity. If you have all of your money tied up in your home since your home is a non-liquid asset and takes longer to sell or turn into cash than if you had invested in mutual funds, bonds, or an investment account.
How to Calculate Extra Mortgage Payments
Using our Mortgage Payment Calculator, you can crunch the numbers and discover how much you could save in interest, or how much you would need to pay each month to pay your loan off sooner.
For example, according to the calculator, if you have a 30-year loan amount of $300,000 at a 4.125% interest rate, with a standard payment of $1,454, if you increase your monthly payment to $1,609, you could pay your loan off five years and one month earlier while saving $43,174 during the loan's lifetime.
Bi-Weekly & Semi-Monthly Mortgage Payments
If you were to go with a biweekly payment schedule, you could add an additional full month's payment towards your mortgage each year. A biweekly payment makes a lot of sense, especially for those who receive their paychecks bi-weekly or semi-monthly.
By paying 26 half payments during the year and paying an extra month's worth, you're putting more money towards the principal balance, which ends up shortening your mortgage. Be sure to check with your bank and make sure they don't charge any fees for switching to a biweekly payment schedule.
On the other hand, let's say you want to pay your loan off sooner but don't want to lock yourself into paying more each month — just in case you run into a month where you need those extra funds for other things. By paying more than the required amount each month, you can pay your loan off sooner while retaining the freedom to pay any additional amount that best suits your budget.
Taking out a 30-year loan, but treating it like and paying it off like it's a 15-year loan, will help you save on interest throughout the loan's lifetime while having the freedom to pay less if necessary.
Lump-Sum Payments
What if you experience a windfall and come into some extra funds? If paying your mortgage loan off sooner is your goal, perhaps a lump-sum payment is the right option to pursue. You can do this by making a one-time payment towards the principal balance. This won't change your monthly payment amount. Instead, it'll go towards the principal and go a long way in helping you pay less interest over your loan term. So while making a lump sum payment, that amount won't make your monthly payments go down, but it will help shorten the term length of your loan.
Prepayment Penalties
Earlier, we mentioned checking with your bank before making any changes to your payment schedule because of the possibility of incurring prepayment penalties. However, these fees are typically rare due to federal laws that keep lenders from charging these fees on mortgage loans like a USDA or FHA.
Remember, some debt is considered good debt to have. A mortgage is one of those. Lenders like to make it more appealing for the borrower to make the monthly payments for the entirety of the loan.
They don't necessarily want to incentivize people to pay loans off early, so when a lender can, they could charge penalty fees up to 2%. In some cases, this fee can only be charged within the first three years of the loan. So we advise you to check and see if your lender charges the prepayment penalty and during what period of time they can charge this fee.
Frequently Asked Questions
Don't worry if you still have questions about whether prioritizing paying your loan off sooner is right for you. You are not alone. Below are some commonly asked questions, but if you still have concerns that were not addressed here, don't hesitate to give us a call at (800) 910-4055.
How many years does an extra mortgage payment take off?
A: If you make one entire additional mortgage payment per year with a bi-weekly payment schedule, it will take twelve years to pay an additional year's worth of your mortgage. If you pay multiple large lump sum payments, you could pay your loan off years sooner.
How can I pay off my 30-year mortgage in 15 years?
A: Of course, this answer depends on the amount of your loan and your standard monthly payment. But for example, if you take out a 30-year loan of $300,000 and your monthly payment is $1,454, you would need to pay an additional $800 onto your principal amount to pay your loan off in 15 years. So instead, you could spread that extra $800 a month out by switching to a bi-weekly payment schedule and pay an extra $400 per paycheck in addition to what's already being taken out for your standard mortgage payment.
Is it better to get a 30-year mortgage and pay extra?
A: If you need flexibility but are determined to pay your loan off earlier, it is a great idea to get a 30-year mortgage and pay whatever extra you can each month. That way, you aren't putting yourself in a tight spot by going with a 15-year mortgage only to find out that it will be a struggle to make the monthly payments. Going with a 30-year mortgage provides you with the choice of how much extra you can pay in a given month, depending on your budget. You will still be able to save on interest by tackling it this way and paying your loan off in less than 30 years.
Is it worth it to pay off a mortgage early?
A: As long as you aren't charged a prepayment penalty by your lender and saving money is your goal, then yes, it could be worth it for you to pay it off early. However, consider that everything depends on your financial goals and what is going on in the housing market. It's always a great idea to talk to a salary-based mortgage consultant when in doubt. Find out more about making
extra mortgage payments
.
Is there a disadvantage to paying off a mortgage?
A: Paying your mortgage off early and closing out an account could impact your credit score. Mortgages are considered "good debt," and paying it off extremely early could negatively affect your score. But, remember, you can always
refinance to a shorter-term
if you are determined to pay it off sooner. In addition, you could possibly get a lower interest rate in the process and be able to pay your loan off sooner.
