You finally own that home you always wanted. You’re benefiting from the financial perks, but with a new home comes a new monthly mortgage payment … and perhaps a new interest rate to consider.
You may not know this, but at the beginning of your mortgage, a lot of that monthly mortgage payment goes toward interest. That’s because your loan balance is still at or near the original amount you borrowed, since you’ve just started paying it off.
When you’re calculating your annual budget with your new mortgage payment, it can be wise to consider paying extra toward your mortgage in the form of an additional payment.
There are three reasons why this could be a smart move for you. You might be surprised at how much money one extra mortgage payment can save you.
Reason #1: Saves Money on Interest
When you pay extra money toward your mortgage payment, you can specify that you want that money going toward your principal.
This will gradually—but noticeably—reduce your loan balance.
And what does a reduced loan balance mean? It means you’ll pay less interest over time. It means you can pay off your mortgage early. It means you’re saving money.
The lower your loan balance, the less interest is added to the mortgage payment each month. These savings won’t affect your monthly payment during the loan. But by the time you pay it off you will have saved thousands of dollars in interest—and reduced the time you’re making those pesky monthly payments.
Reason #2: Build Equity Faster
As you reduce your principal and interest, your equity increases (assuming home values are maintained). Having equity built up in your home increases the value of your investment, which translates to increased profits if and when you decide to sell.
Equity also provides an option for future home improvement loans, if needed.
And if you have less than 20% equity and are paying PMI (private mortgage insurance), those extra payments will help get you to the 20% threshold faster so you can eliminate the PMI payment.
Reason #3: Pay Off Your Mortgage Early
What can one extra payment a year really do to the term of your loan?
That one additional payment may help you pay off your mortgage as much as three to four years early—and if you make more than one additional payment per year, it’s even faster!
Not only do you save money on interest, but you’ll be clear of having a mortgage payment at all much more quickly.
Just think about what those dollars could be used for. College tuition, vacations, a second home, or even an investment property. That one extra payment allows you to build long-term wealth.
In the end, it doesn’t matter what you do with the extra money—the point is that it’s your decision to make. Even if your goal is simply to become debt-free, those extra mortgage payments will get you there faster.
How to Make an Extra Mortgage Payment
There are multiple ways you can make extra mortgage payments. Here are three strategies that might work for you:
1. A Lump Sum Payment
Save any extra money throughout the year until it equals one extra mortgage payment. Then send it in at any point during the year, but be sure to specify that this is a principal-only payment.
If you’re not sure how to do this, contact your loan servicer for instructions.
2. Extra Dollars in Each Monthly Payment
Divide your monthly mortgage payment by 12, and then add that amount to each monthly payment.
For example, if your monthly mortgage payment is $1,200, that would be 1,200 divided by 12 months, which equals $100. That’s the extra money you would add to each monthly payment to chip away at your mortgage balance.
In this scenario, you would then increase the amount you send in for your mortgage payment to $1,300 a month ($1,200 + $100). Be sure to confirm that the extra funds will be applied to your principal loan balance.
3. Biweekly Payments
Just like you might be unaware of what a dent an extra mortgage payment can make in the life of the loan, you may not realize what a biweekly payment can do.
By simply dividing your monthly payment in half and paying that amount every other week, you’ll create an additional payment every year. That’s because the length of each month varies, but the number of weeks in a year does not.
Relying on a biweekly schedule allows you to capitalize on this discrepancy, resulting in an extra payment. After all, 26 half-payments per year is equal to 13 whole payments … giving you an extra payment and hardly noticing it!
Before You Dive In
Now, a few disclaimers. Before you decide to start making extra mortgage payments each year, you want to make sure you’re financially healthy.
If you have high-interest debt or a 401(k) that needs to be funded, any extra money may be better spent on these items.
You should also keep an emergency fund that can cover at least three months—but ideally six months—of living expenses. This will protect you in case something happens to your employment or income.
Lastly, you want to check with your loan officer to ensure that your mortgage doesn’t carry prepayment penalties. Most of these penalties apply to much larger paydowns, but you’ll want to be sure before you start sending in money.
One thing to note is that these penalties expire after a specified amount of time (usually no longer than five years), so if you have such a penalty, just sock the extra money away and make one larger payment after the penalty period expires.
Though one additional mortgage payment per year may seem like a drop in the bucket, especially early in the life of the loan, this extra money will soon add up.
Before you know it, your diligence will help you reach your goals sooner.
Ready to put that extra money toward your mortgage payment and understand the savings you could unlock? Need further clarification book a call today!
