Should You Pay Extra on Your Mortgage?
Point of Interest
Many people save on the costs of their home by making extra mortgage payments, but should you pay extra on your mortgage? The answer requires you to look at your full financial picture so you can see if the savings will beat out other payment or investment options. It’s important to know how much you can potentially save by paying extra on your mortgage, along with various payment strategies and how to figure out if it’s the best move for you.
Paying extra on your mortgage
Paying extra on your mortgage means that you make additional payments to your principal loan balance beyond your regular payments. For example, if you pay $1,300 per month normally, you may pay an extra $200 to the principal for a total payment of $1,500. Or if you get a bit of money, say a $5,000 tax refund, you could apply it to your principal loan balance. The faster you pay off your mortgage, the less you will pay in interest, reducing your overall loan cost. However, this option should be considered in the context of your larger financial situation.
How much will you save by making extra payments?
The amount you can save by making extra mortgage payments is one of the first things you need to figure out as that number will enable you to compare it to other options. Let’s take a look at how much you could save on interest over the life of a 30-year, $200,000 loan with a 3.5% interest rate if you paid $50, $100 and $250 extra each month.
|Extra Monthly Payments||Monthly Interest Savings||Time Saved|
|$50||$12,356||2 years, 7 months|
|$100||$22,367||4 years, 9 months|
|$250||$43,638||9 years, 7 months|
Just paying an extra $50 per month will shave 2 years and 7 months off the loan and will save you over $12,000 in the long run. If you can up your payments by $250, the savings increase to over $40,000 while the loan term gets cut down by almost a third.
The savings can be substantial. Use a mortgage calculator to figure out your estimated savings. Then, compare that to the savings or returns you can get by investing the same money elsewhere.
Ways to prepay your mortgage
Pay more every month
The first option is to analyze your budget and see if you can afford to increase the amount you pay on your mortgage each month. Even if you can only commit to $25 or $50, it can save you thousands over the course of the loan.
Make an extra payment each year
Another option is to make one extra payment each year that is equal to your normal payment amount. This can be a good option if you get a bonus or tax refund each year.
Make a lump-sum payment
Sometimes situations come about which leave people with a lump sum of money, like receiving an inheritance. While exciting, it can also be stressful because you want to use the money wisely. Using lump sums to pay down your mortgage helps to reduce your interest and increase equity faster, which is a helpful investment. It can also ensure that the money is invested rather than spent.
Mix it up
You can also use a combination of these approaches, such as paying a little bit more each month and then making a larger one-time payment when you can.
The right payment strategy for you will depend on your financial situation. For example, if your budget is tight and you can’t commit to paying more every month but have certain months when your income is higher, you can commit to making an extra payment during those months. Alternatively, if you don’t receive any income boosts throughout the year but have a little bit of disposable income each month, the monthly payment option will be a better fit.
When not to pay extra
Paying extra on your mortgage can be helpful but it isn’t always the best use of your money.
“Whether you should pay extra on your mortgage or not depends on the rest of your financial picture. If you have credit card debt, an expensive car loan, or other high-interest debt, you’ll want to pay that down before making extra payments on your mortgage,” Matthew McEwan, VP of real estate development and property management firm Medallion Capital Group, said.
“Additionally, if you are a savvy investor who can tolerate some risk, you may be able to achieve a higher rate of return by investing that money instead,” McEwan said.
What to do before paying off your loan early
Before you pay off your mortgage early, there are a few things you should do. For one thing, you’ll want to meet all of your regular necessary expenses (rent, food, clothing, etc.). Next, ensure you pay off any debts you have with interest rates that are higher than the interest rate on your mortgage. For example, if you have a $5,000 balance on a credit card with an 18% APR and your mortgage has a 4% APR, you’ll save more by paying down the credit card first.
It’s also recommended to make sure that you have an emergency savings account that is equal to at least three months of pay, and preferably six. Moreover, confirm that you and your dependents are enrolled in the insurance policies you need to protect yourselves in the future. This often includes health, property, auto, disability and life policies.
If you have an employer offer to match your retirement savings up to a certain percentage, max out the company contributions. The earlier you invest in retirement, the better.
“You’ll also want to look at the tax implications of paying down your mortgage faster. If you are self-employed or if the mortgage is on investment property, you need to factor any available tax deductions into the equation when deciding the best use for your money,” McEwan said.
You should also analyze your investment portfolio to see if paying your mortgage could save you more than you’re earning. If you have all of these things squared away, paying down your mortgage may just be the right move.
The bottom line
Whether or not you should pay extra on your mortgage must be decided on a case-by-case basis. It is a move that can save you money on interest — there’s no question about that. However, what you have to figure out is if those savings are the most beneficial to your whole financial picture.
First, make sure all of your basic necessities are met. Then look at all of your debts and investments to determine where your money will be best utilized. Make a simple spreadsheet that shows how much you will save or earn in each scenario.
In most cases, you’ll want to pay down your debt with the highest interest rates first. Look at investment options after your higher interest debts have been paid down. Low-risk investment vehicles like CDs often offer lower returns than what you’ll save by paying down your mortgage, so run the numbers. Also, consider whether you would prefer to invest the money in higher-risk options that could potentially pay you back more. After a full analysis, you will be able to make an informed decision on whether paying down your mortgage is the best decision for you.