Home > Mortgage > What happens if You Make Additional Principal Payments on a Mortgage

What happens if You Make Additional Principal Payments on a Mortgage

October 19th, 2012 Leave a comment Go to comments

debt repaymentMost mortgages have a term of 15 or 30 years, but many are repaid early as the borrower wants to pay off or refinance their debt early. They want to lessen their mortgage debt by making additional payments on their loans. Paying off your mortgage before time has advantages. You don’t have to be anxious about how you would manage to pay for your mortgage payments in case you are laid off. You can also take the money you would have spent on the payments and invest it.

Many borrowers feel like reducing their mortgage debt by making additional payments on their loans and to do this make sure the extra payments are applied toward the principal of the loan and not future payments. You can find this distinction on the payment coupon for the mortgage. While applying extra payments to principal decreases the total interest paid on the loan, the monthly payment on the debt will not reduce as it does with credit card or revolving debt. The monthly payment will remain the same, in spite of extra payments made. To know more about this check out Mortgage Life Insurance guide.

What Would Extra Principal Payments Do to My Mortgage?Mortgage Application Form

Certainly, making an extra payment every year or six months can shave time and money off the mortgage especially while buying a house. But some financial specialists consider that there are better things to do with the money.

Reduce Interest Paid

When you add extra mortgage payments, it not only reduces the principal and cuts down the life of the loan, but also shrinks the amount of interest you will pay over the life of the loan. Even though your monthly payments won’t be smaller, one extra payment a year can save you thousands of dollars in interest applied to the loan that would have been your duty to pay.

For instance, if you made just one extra $1,000 payment at the beginning of a 30 year mortgage at 6.25%, you would save more than $5,000 in interest payments over the life of the loan. If, instead of the one-time $1,000 extra payment, you added $20 of the principal payments each month you would reduce your interest by more than $12,000.

Effects on Mortgage Payments

When you make extra payments on your mortgage, your monthly payment will not alter. The monthly payment is set when you take out the mortgage and does not vary unless you refinance your loan. However, the composition of the payments changes as more of your monthly payments will go toward paying down the principal instead of paying interest.

Reduce the Mortgage Term

Prepaying what you owe on your home decreases the life of the mortgage. For instance, if you had a $20,000 mortgage for 30 years at a 7% interest rate and you decided to pay an additional $200 each month, you would cut almost 10 years off the life of the mortgage.

Check the paperwork when considering refinancing your mortgagePrepayment Penalties

Decreasing your interest payments is good for you but not profitable for your lender. Some mortgages carry a prepayment penalty clause, which charges a fee if you pay off your mortgage before a specified period of time or if you make a lot of extra payments. These are generally between one and five years and can apply to a certain percentage of the loan or the entire loan. The penalties can amount to about 6 months of interest payments.

Other Options

If you are bearing in mind prepaying your mortgage, think about the potential return on other investment opportunities, In case your mortgage has a low interest rate, consider investing some of your extra payments in a mutual fund or stocks that pay a higher rate of return.

For instance, if your mortgage charges 6% interest and a mutual fund will return 9%, you could put on 3% by investing in the mutual fund. You also will gain if you detail your tax deductions as your tax mortgage is tax deductible.

Make an extra mortgage paymentWhen to Pay Extra on Mortgage?

Some people find it easier to make lesser payments each month, while others like to make large lump sum payments on their mortgage. Not considering the method chosen, the major impact on the life of the loan and the overall interest paid is in the first 3 years of the loan. During this time, most of the monthly payment is going toward the interest and not the principal.

Even if you cannot afford to carry in paying extra month and if you did it during the first three years, you would see a remarkable reduction in overall interest paid.

Warning!

Many borrowers select a 15-year mortgage to lessen overall interest expense but extend their budgets to do so. Mortgage lenders recommend choosing the 30-year term option but paying on it as if it was a 15-year mortgage. So in the event of large payments, you can make the lower payment one month and start again the higher payments next month.

Some lenders will provide you a prepayment program of their own, but these generally aren’t worth worrying with. Borrowers who use the programs end up paying a signing fee and perhaps a monthly fee for something they could have done on their own at no additional charge.