Paying off your mortgage early can help save thousands of dollars in interest. But before you start throwing a lot of money in that direction, you’ll need to consider a few factors to determine whether it’s a smart option.
In this article, w e’ll share some of the pros and cons of paying off your mortgage early and give you a few tips you can use to reduce the interest you’ll pay on your loan.
Every time you make a mortgage payment, it’s split between your principal and interest . Most of your payment goes toward interest during the first few years of your loan. You owe less in interest as you pay down your principal, which is the amount of money you originally borrowed. At the end of your loan, a much larger percentage of your payment goes toward principal.
You can apply extra payments directly to the principal balance of your mortgage. Making additional principal payments reduces the amount of money you’ll pay interest on – before it can accrue. This can knock years off your mortgage term and save you thousands of dollars.
Let’s say you borrow $150,000 to buy a home at 6% interest with a 30-year term. By the time you pay off your loan, you’ll have paid a whopping $173,757.28 in interest. This is in addition to the $150,000 you initially borrowed.
Now, let’s say that you pay an extra $100 every month toward a loan with the exact same term, principal and interest rate. At the end of the term, you’ll have paid $128,170.57 total in interest. That’s $45,586.71 less than you would have paid if you didn’t make any extra payments. You’ll also pay your loan off 81 months earlier than you would if you only paid your premium each month.
Paying down your mortgage early reduces the amount that you’ll pay over time, but many finance experts agree that you shouldn’t always focus on paying off your loan as soon as possible. Some believe that people should concentrate on investing rather than paying off their mortgage early, putting that money into a retirement account or an investment fund. Others believe it’s better to use the money that would have gone to extra payments to pay down other sources of debt.
The decision to pay off your mortgage early is a personal one that depends heavily upon your individual circumstances .
If you find yourself with a little extra cash at the end of the month, should you put it toward your mortgage loan or refinance to a shorter term? There’s no simple answer. Risks and benefits exist when paying off your loan early or switching loan terms, so the right decision differs for everyone.
In this section, we’ll look at a few instances in which it makes sense to pay off your mortgage early – and when it doesn’t.
You might assume that you need to shell out hundreds of extra dollars each month to pay off your mortgage early. The truth is, a small monthly amount or a single annual payment can make a major difference over the course of your loan.
Contributing just $50 extra a month can help you pay off your mortgage years ahead of schedule. You don’t need to find a way to earn an extra $10,000 a year to pay off your mortgage.
If you’re looking for a tool that can help you understand amortization and estimate what paying off your mortgage early would cost you, try using our Rocket Mortgage ® amortization calculator. It’ll help you see for yourself how a small amount can impact your loan. Your result might surprise you. Most people can manage to save at least a few thousand dollars in interest with a small monthly extra payment. This is especially true if you start paying more on your loan in the early years of your mortgage.
The best candidates for early mortgage payoffs are those who already have enough money to cover an emergency. You’ll want at least 3 – 6 months’ worth of household expenses in liquid cash before you focus on paying off your mortgage. This is because it’s much more difficult to take money out of your home than it is to withdraw money from a savings account.
It may not be a good idea to focus on paying off your mortgage early if you have other debt to worry about. Credit card debt, student loan debt and other types of loans often have higher interest rates than most mortgages. This means they accrue interest faster.
By paying these debts down, you’ll save more than you would if you put all your money toward your mortgage. It’s best to review your financial paperwork and compare interest rates of your other debts to your mortgage interest rate. If your other debts have a higher interest rate, you should pay them down first.
You also may want to avoid paying your loan off early if it carries a prepayment penalty. This is a fee your lender charges if you make all payments your mortgage prematurely. Prepayment penalties are usually equal to a certain percentage you would have paid in interest.
So , if you pay off your principal very early, you might end up paying the interest you would have paid anyway. Prepayment penalties usually expire a few years into the loan.
Consult your mortgage lender and ask about any prepayment penalties on your loan before you make a large extra payment. Prepayment penalties are also noted in your mortgage contract.
While it’s possible to take cash out of your home equity with a refinance, this process takes time, which you may not have in an emergency. Make sure you have plenty of money set aside for emergencies before you put any extra toward your mortgage loan.
You may want to delay paying off your mortgage if you have another big expense coming up or you’d rather put money into your 401(k) or IRA. You might also want to consider diverting your extra money into a child’s college fund or into savings for an upcoming vacation or wedding.
There’s no point in paying off your mortgage if it means you might end up going into debt in the future .