No doubt you have read all about it, perhaps you have even tried it yourself — paying extra on your mortgage to pay it off early and potentially save thousands in interest. The question is, however, with interest rates on the rise, is it still the best strategy?
While some financial experts say prepaying your mortgage is never a good idea, others disagree. Those who say not to prepay contend stocks and other investments have performed better over time. Those in favor of prepayment say paying your mortgage early is the smart thing to do — why pay interest on money needlessly?
While the discussion will always be ongoing, let’s take a quick look at the most popular ways to prepay your mortgage. Some financial advisers like the bi-weekly strategy of making half your monthly mortgage payment every two weeks – or 26 half-payments a year rather than 12. Depending on your outstanding loan balance and payment amount, the extra monthly payment each year can shave months or even years off the remaining term of the loan.
Then, there’s the lump-sum prepayment option. By making a lump-sum payment to the principal balance, you can save a substantial amount in interest. Just make sure your lender understands you want to apply the lump-sum payment directly to the principal to avoid any confusion.
Making extra principal payments does have a noticeable effect. By reducing the outstanding principal balance of your loan, you can have a larger amount of every future payment applied to principal and less to interest, thereby reducing the principal faster – and saving on interest.
Let’s look at an example:
Say a borrower has a $300,000 loan at 4 percent with a monthly payment of $1,432.25. During the first month, $1,000 would be applied to interest and only $432.25 to principal. After 10 years, the remaining balance would be approximately $236,000, with $788 going to interest and $644 being applied to principal. After 20 years, the balance would be down to about $141,000, with the principal portion of the payment being $960 and the interest portion $472. The final payment would be $4.75 in interest and $1,425 in principal (all amounts are approximate).
Using this example, for the life of the loan the borrower would repay the $300,000 and pay $216,000 in interest.
By making an additional principal payment of just $100 extra each month, the borrower would pay the loan off 3.5 years early, saving nearly $29,000 in total interest.
Prepaying your mortgage, of course, is a personal decision and should be discussed with your financial adviser or accountant. However, for many people who can afford to make additional payments to principal – either bi-weekly, monthly or in a lump sum – it can mean saving thousands of dollars in interest. And that’s money that can be re-invested in home improvements, to purchase additional real estate, or set aside for retirement.
If you have questions about your mortgage needs, we at ALCOVA Mortgage would love to assist you. Our knowledgeable loan officers and staff stand ready to be of service. Call us today … we’re here to help.