Prepaying Your Mortgage: How Reducing Your Loan Principal Can Lead to Big Savings
The title says it all folks. Read & save some money in 2019.
Prepaying your mortgage: How reducing your loan principal can lead to big savings
When you prepay your mortgage, it means that you make extra payments on your mortgage principal. Prepaying can save you thousands of dollars in interest, pay off your loan early and build equity faster.
There are several ways to prepay a mortgage:
Apply a lump sum after an inheritance or other windfall.
Make an extra payment every year.
Add extra dollars to every payment.
Some combination of the above.
How much can prepaying a mortgage save?
The benefit of prepaying your mortgage isn’t just in reducing the monthly interest expense a tiny bit at a time. It comes from paying down your outstanding loan balance with additional principal payments, which slashes the total interest you’ll owe over the life of the loan.
Here’s an example of how prepaying saves money and time: Kaylyn takes out a $120,000 mortgage at a 4.5 percent interest rate. The monthly principal and interest total $608.02. Here’s what happens when Kaylyn makes extra payments:
What are the drawbacks of prepaying my mortgage?
There are potential downsides to prepaying. For starters, typing up your cash in your home means you have less liquidity and wiggle room in your budget. In other words, you’ll have less readily available cash to put toward increasing your 401(k) contributions or paying down high-interest debt. These financial goals could offer a higher return on your investment.
Another consideration is the opportunity cost of not having that extra money invested elsewhere. Over the past four decades the stock market has returned an average of 10 percent a year. For the broad bond markets, the average annual gain has been close to 8 percent.
When asking yourself, “Can I prepay my mortgage?” look at your entire financial picture. Here are some important questions to consider:
Is your monthly budget tight after meeting necessary expenses?
Is your income variable and/or unpredictable?
How long do I plan to stay in my home?
Are you saving enough for retirement?
Do you have an adequate emergency savings fund of three to six months of household living expenses?
Do you have a lot of high-interest credit cards or loans?
Assessing your financial goals, income and budget can help you decide whether it makes more sense to address other pressing financial concerns before paying ahead on your mortgage.
Do it yourself
Let’s say you want to budget an extra amount each month to prepay your principal. One tactic is to make one extra principal and interest payment per year. You could simply make a double payment during the month of your choosing, or add one-twelfth of a principal and interest payment to each month’s payment. A year later, you will have made 13 payments.
Make sure you earmark any additional principal payments to go specifically toward your principal. Lenders typically have this option online or have a process for earmarking checks for principal payments only. Ask your lender for instructions. If you don’t specify that the extra payments should go toward the loan principal, the extra money will go toward your next monthly mortgage payment. And that won’t help you achieve your goal of prepaying your mortgage.
Once you have built sufficient equity in your home, you should ask your lender to remove private mortgage insurance, or PMI. Paying down your loan principal at a faster rate helps eliminate PMI payments more quickly, which also saves you money in the long run.