Pre-Paying Your Mortgage: Benefits And Drawbacks

Posted by Nick Niesen on October 29th, 2010

House payments can take up a large portion of your paycheck, and paying even more toward your mortgage every month may seem like an overwhelming idea. What you may not realize, however, is that paying a little more can save you thousands of dollars over the life of the loan.

Before you put all of your extra money toward your house, consider the following to make sure it is best for your financial situation:

Benefits

Prepaying on your mortgage can save you tens of thousands of dollars. If you have a loan of $100,000 at 8% interest for 30 years, you will pay $264,240 in interest. That same mortgage held for 15 years produces only $172,080 in interest, saving you a whopping $92,160.

Drawbacks

· It depletes the liquidity of your finances, and you won?t have that money immediately available.

· It is best to have a safety net with savings for at least 6 months before putting a lot of extra money into a mortgage.

· Paying less interest on your mortgage can affect your tax picture (although paying higher interest is not a valid reason to keep a mortgage).

· It does not make financial sense to pay extra on your mortgage if you are in high interest consumer debt. Pay off other high-interest debts first.

· The lower the APR, the less you save. You may be able to invest your money elsewhere with a higher return.

If you are serious about prepaying your mortgage, consider paying the next month?s principal amount with the current house payment. Early on in the loan, the majority of your monthly house payment goes toward interest, often leaving as little as $40 to $60 going toward your principal balance.

Obtain an amortization schedule of the loan from the lender, realtor, or online site. When you are making your January house payment, look ahead and make an additional payment to include February?s principal amount. This essentially eliminates one full payment from the loan schedule because the loan balance after that payment would correspond to the loan balance shown at the end of February.

Let?s say your monthly payment on a 30-year $100,000 loan at 8% is $733.77. In the first month, $666.67 of that amount goes toward interest and $67.10 goes toward the principal. The second month?s payment includes $67.55 toward the principal, so you would only need to pay that much extra with the first month?s payment.

If you follow this schedule throughout the loan, your mortgage can be paid off in almost half the time.

When you are paying extra on your mortgage, clearly document it. Always use a separate check, and clearly mark the loan number and ?principal prepayment? on it. Using a separate check will allow you to track it to make sure it posts toward the principal and not late fees, advanced interest, insurance premiums, or tax.

Before starting any prepayment plan, check with your lender to make sure you do not have a prepayment penalty. You can sometimes get a slightly lower APR if you have a prepayment penalty, and many lenders will assume you prefer that without checking with you.