Having debt, even “good” debt like a mortgage, can be a major stress in your life. It can be especially frustrating when you see how much of your hard-earned cash is going to pay off interest on your loan and not the home’s principal cost. You could end up paying as much as double your home’s sticker price over the term of your loan. But prepaying your mortgage can help you keep money in your pocket.
By paying more money monthly, you can cut down on the interest you owe, get your home paid off sooner and build equity faster. It can even help you reach retirement sooner. But before you jump on board, it’s important to carefully assess your financial situation and understand the basics of mortgage prepayment.
How to Prepay
First, it’s important to know the interest rate and remaining balance on your mortgage, then decide how much you want to (and are able to) prepay. You can contribute a lump sum to cut down the overall cost if you have received an inheritance, bonus or other windfall. You can also add a few dollars to each payment, make an extra (13th) annual payment, or some combination of these options.
Next, make sure that your mortgage allows you to prepay and doesn’t include a prepayment penalty. Then contact your bank or mortgage company and verify that all extra contributions will be applied directly to the principal. You can then automate this larger or additional payment so you can stay on track without having to do so manually.
Difference Between Refinancing &Â Prepaying
Prepaying may seem similar to refinancing your mortgage, as both can help you pay off your mortgage faster. Refinancing, however, requires getting an all-new mortgage with new terms and paying closing costs again. You’ll also need to go through a credit check again, and if you haven’t been paying close attention to your scores, that could be problematic for you. (You can see where your credit scores stand for free on Credit.com.) This is generally done to reduce interest rate, reduce payments or reduce risk of future rate increases. It’s important to calculate the point when monthly savings of the new mortgage become greater than the upfront costs of the refinance process.
The prepayment decision, by contrast, is more of an investment decision. You should consider your aversion to risk and whether prepaying your home or putting those funds into CDs or bonds will earn better yields. This includes both the better option financially and emotionally, since some people sleep better at night being debt-free.
So, Should I Do It?
Deciding to make prepayments on your mortgage is a personal financial issue. Prepaying reduces mortgage interest, which is tax-deductible and may not be a smart move depending on your tax situation. It’s also important to consider if your return on investment might be higher elsewhere. As with any other large financial decision, you should be assessing your overall goals.
Getting rid of higher-interest debt (like from a credit card or private student loan) may be a smarter decision than making mortgage prepayments. It’s a good idea to make sure you are contributing enough to your retirement savings plans to ensure you are on track for a comfortable retirement before pooling extra funds to finance your home. Prepaying has the potential to save you thousands of dollars in interest, but it isn’t right for everyone (you can check out your lifetime cost of debt here). It’s important to weigh the pros and cons carefully.
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