With mortgage rates still sitting near historic lows, odds are good that you won’t have an opportunity to refinance for lower rates in the future. Of course, you could find yourself in a situation where you need to refinance to get equity out of your home, but it’s unlikely that refinancing in the future will translate to saving on your mortgage. So, assuming you’ve refinanced to lock in today’s low rates, what else could you do to save money on the life of the loan? One option is to make additional principal payments. Just making 2 extra mortgage payments a year can save you tens of thousands of dollars and cut years off your loan.
When we discuss making 2 extra mortgage payments a year, we don’t mean that you have to make extra payments exactly twice a year. You could make smaller payments on a monthly basis, you could pay an extra half of your normal mortgage payment quarterly, or you could make a lump sum payment once a year.
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You may be able to simply increase your normal monthly payment, or your lender or mortgage servicer may have an alternate process in place for additional principal payments, so it’s important to check with them to make sure that your additional payments are being applied to your loan principal and not just your next monthly mortgage payment.
By making 2 extra mortgage payments a year you’re prepaying principal that would otherwise accrue interest over the life of the loan, plus those payments are accelerating repayment because they’re payments you would have made anyway.
You can find prepayment calculators on websites like Bankrate or MortgageCalculator.org (MortgageCalculator’s advanced calculator provides additional prepayment options) and see exactly how 2 extra mortgage payments a year will affect your specific loan, but if you have a relatively recent loan, you’re likely looking at tens of thousands of dollars in savings and cutting as much as eight years off the life of your loan.
Obviously, not everyone can afford to make 2 extra mortgage payments a year. You’re basically increasing your housing costs by 16%. That being said, if you can check off the following items, it might be a smart decision.
Make 2 Extra Mortgage Payments a Year if…
You’ll be in your current home for most or all of the life of the loan. The value of extra payments is realized through a reduction in the life of the loan and interest savings over 20+ years; you won’t realize nearly the same benefits if you’ll only be in the home 5-10 years.
You’re already maximizing other savings. If you don’t already have emergency savings, if you’re not taking advantage of your employer’s 401k matching, or if you’re not setting aside money to invest for the future you shouldn’t make extra mortgage payments. Prioritize saving for emergencies and growing your net worth before you start allocating extra money towards your mortgage.
Your income is stable and predictable. If you have reliable income, it’s much easier to earmark a portion of it for additional mortgage payments. That’s not necessarily the case if your income is highly variable. That being said, a large or unexpected bonus or sales commission is great to tap into to boost your savings. Just don’t tie up all your liquidity in an illiquid asset like a home.
The decision to make 2 extra mortgage payments a year will ultimately be highly individual. Some homeowners may need to prioritize setting aside money for other uses, like retirement, higher education, rental properties, or emergency savings. But if you’re thinking about prepaying your mortgage, you should take a moment and explore the mortgage calculators above. It’s a good first step to see what effect those extra payments will have on your finances.
Is reducing the life of your mortgage or saving money on interest a bigger priority when you think about prepaying your mortgage?