A mortgage means that someone else has a stake in your home with you holding the remaining stake. You’re only a partial homeowner until that mortgage is paid off, something you can do by prepaying the loan by making extra payments over and beyond what is due each month.
Let’s say your mortgage is a nice round $1,000 per month, not including property taxes, association fees and insurance. You could make that payment once monthly or you could make payments biweekly. By paying $500 biweekly, you do two things:
1. You reduce the interest that accumulates throughout the month, and
2. You end up make one full extra payment each year.
Let’s take a look at the traditional way to make payments: monthly. In this example you have a 30-year fixed-rate mortgage at 5 percent interest and a $150,000 home loan. Your monthly payment is $805.23 and you’ll make total payments of $289,883.68 with $139,883.68 total interest paid.
If you were to make biweekly payments of $402.62 each, you would shave four years, 9 months off the term of your mortgage. Moreover, your total interest paid would drop to $114,116.24 for a net interest savings of $25,767.44.
One Extra Payment
Let’s say that bi-weekly payments are too much of a hassle for you, but you still want to knock down your mortgage faster and save money. Another option is to make a 13th payment during the calendar year, perhaps each May following the filing of your tax return.
This option provides nearly identical results, reducing your interest payments to $114,185.39. It would also shave four years, 7 months off your mortgage term with a token $69.21 payment for that final month.
Please note that some lenders hit borrowers with prepayment penalties if they make extra payments. You need to check your mortgage agreement to find out if such a restriction is in place.
Typically, lenders allow homeowners to prepay without penalty, but they may add in a penalty if you decide to refinance, let’s say within five years. However, if you sell your home, the lender may not consider that a prepayment. Keep in mind that prepayments and refinancing cut into the bank’s profits, therefore they have a vested interest in keeping your loan going.
Prepaying your mortgage is a wise option if you can afford to do so. Explore this option if you have money left over each month and your other accounts (retirement, savings, rainy day, et al) are fully funded. Prepaying a mortgage shouldn’t strap you and it should align with your financial goals including attaining a debt-free lifestyle.