Thirty years is a long time. If you’re chipping away at a mortgage each month, it can feel even longer.
But what if you could eliminate that financial ball and chain by paying off your mortgage early?
The truth is, if you can scrape together the equivalent of one extra payment to put toward your mortgage each year, you’ll take, on average, four to six years off your loan.
You’ll also save tens of thousands of dollars in interest payments.
We’ll break down exactly how it works, how much you can save and strategies you can use to squeeze an extra mortgage payment out of your budget.
How It Works
Most people can’t afford to buy a house outright in cash. Instead, you pay a percentage of the total cost, known as a down payment, and take out a loan for the rest. That’s your mortgage, and it’s typically paid back over 20 or 30 years.
Principal and interest are the main components of your mortgage payment. The principal is the original amount you borrowed and interest is what mortgage lenders charge for lending you the money.
Your regular monthly payment may also include private mortgage insurance (PMI), a fee that goes away once you’ve paid off 20 percent of the principal.
In the beginning, most of your monthly mortgage payment goes to interest because your loan balance is so high. Only a little goes toward paying off the loan principal.
Paying down the principal means you owe less interest each month because your loan balance shrinks.
Making extra mortgage payments — and applying them to the principal — reduces your principal balance little-by-little, so you end up owing less interest over the life of the loan.
And when you owe less interest, you can trim years off your mortgage term.
Additional principal payments also build home equity and help eliminate PMI faster.
The cost of PMI for a conventional home loan averages 0.58% to 1.86% of the original loan amount per year.
If you put a 5% down payment on a $275,000 30-year loan term, you could be paying $126 to $405 a month for PMI alone. The sooner you can get 20% of your principal paid off, the sooner you can eliminate this additional monthly cost.
Here’s How Making One Extra Mortgage Payment Can Save You Thousands of Dollars
Curious what kind of impact an extra mortgage payment can make?
Let’s say you have a 30-year mortgage on a $275,000 home with a 4.5% interest rate. Your regular monthly payment is $1,393.
Pay-off date: November 2051
Total interest paid: $226,618
See how the total interest nearly adds up to the purchase price of the house? Ouch.
If you make an extra monthly payment of $1,400 each December, you’ll pay off your 30-year mortgage 4.5 years ahead of schedule and net nearly $40,000 in interest savings in the process.
Pay off date: May 2047
Total interest paid: $186,999
You read that right: $40,000 you won’t be paying in interest.
But we realize that coughing up $1,400 around the holidays can be tough.
So instead let’s imagine you increased your mortgage payment by one-twelfth ($117) each month. Instead of paying $1,393 you’d pay $1,510.
The results are nearly identical, although making an extra mortgage payment at the end of the year saves you a tiny bit more money on interest.
Pay off date: June 2047
Total interest paid: $188,301
3 Ways to Make an Extra Mortgage Payment
There are a few different ways you can make extra mortgage payments in a year.
No matter which method you choose, it’s important to tell your loan provider that you want the extra payment applied to your principal balance. Otherwise, extra payments might go toward the interest — which doesn’t help you pay off your mortgage faster.
One Lump-Sum Payment
Save up money throughout the year and put it in a special savings account. At the end of the year, empty the account to make your 13th monthly payment.
You can put extra money from tax refunds, bonuses at work or other unexpected income into the account to build it up faster.
Another option is setting up automatic recurring monthly deposits from your checking account to the savings account each month. This way, you’re not scrambling to come up with your bonus mortgage payment when December rolls around.
Add Extra Dollars to Each Monthly Payment
Divide your monthly mortgage payment by 12 and add that amount to each month’s payment.
That extra amount should automatically get applied to your principal loan balance, but verify with your mortgage company just in case.
Paying a little above the minimum payment each month is easier for some people than making a lump-sum payment.
Some mortgage servicers let you sign up for biweekly mortgage payments. This lets you pay half your mortgage bill every two weeks instead of once a month.
Doing so results in 26 half-payments — or 13 full monthly payments — each calendar year.
Be aware that some lenders may charge extra fees if you opt for biweekly payments, while others may not offer this service at all.
Before You Start Making Extra Payments
Before you start making extra mortgage payments, talk to your loan company.
Some lenders charge prepayment penalties if you pay your mortgage off ahead of schedule.
If your mortgage includes this clause, you can still repay your loan early, but you’ll need to save up extra money to offset the prepayment penalty amount.
As we discussed earlier, it’s crucial to make sure any extra payments apply to your mortgage principal. Most companies give you this option online but you may want to call them to confirm that your extra cash is going to the right place.
Finally, make sure your finances are in good shape. You’ll need to examine your entire financial picture and determine if your dollars are better spent elsewhere.
Is being completely debt-free your top financial priority, or could your money be working for you in other ways?
If the interest rate on your mortgage is low, it might be wiser to put extra money in your company’s 401(k) plan, save for a child’s college tuition or pay off other debts with higher interest rates, like credit cards and student loans.
You also need to maintain a healthy emergency fund, with enough money left over to cover your monthly expenses.
As long as you’re not neglecting other financial goals and your budget can afford it, making an extra payment each year is a smart way to pay off your mortgage sooner.
You won’t see the fruits of your labor right away, but your hard work will be worth it when you own your home free and clear years ahead of schedule.
Rachel Christian is a Certified Educator in Personal Finance and a senior writer for Codetic.