One of the most common questions I get from my mortgage clients is “How can I get ahead?” Buying a home is a big financial step and a great opportunity to build equity, so it’s only natural homeowners explore options that will allow them to pay off their home sooner and minimize the amount of interest they pay. The piece of advice I give to these homeowners is to prepay their mortgage whenever possible.
What does prepaying your mortgage actually mean?
Prepaying your mortgage simply means to make extra payments on your principal loan balance. You can prepay your mortgage a few different ways:
- Make monthly payments that exceed your usual or minimum payment.
- Make a lump sum payment at any time in the year in addition to making regular monthly payments.
- Make 13 or more payments in a year rather than the traditional 12 payments.
- A mixture of all the options above.
Making slightly larger payments each month is the most common way homeowners prepay their mortgage, but lump sum payments are popular too, especially during tax refund season. Most homeowners receive federal and state tax refunds for their homeownership expenses, and I often recommend to my clients that they put those funds toward their mortgage if possible.
Why prepay your mortgage?
Your goal may be general, such as to pay off your mortgage sooner, build equity faster or reduce total interest paid. Your goal can also be more specific. For example, your goal may be to make additional payments until you pay off 20 percent of your home so you can stop paying private mortgage insurance (PMI). Either way, the benefits of prepaying your mortgage can be substantial.
A few things to consider
Keep in mind when making larger monthly payments, additional or lump sum payments that you may need to designate the funds to be put towards principal. Some loan structures automatically direct extra funds toward principal, while others will apply extra payment towards your next monthly payment if not manually designated to apply to principal, and this will not help pay your mortgage off faster.
Another important thing to keep in mind is that while prepaying your mortgage comes with great benefits, in some households, it may mean a tighter overall budget or less discretionary money. Consider other financial responsibilities, such as keeping an emergency fund and growing your retirement savings before directing extra funds to your mortgage.
Additionally, consider other forms of debt you have that could be more beneficial to pay off. For example, you may save more on interest costs by prepaying high-interest loans or credit cards before prepaying your mortgage.
Before paying ahead on your mortgage, be sure to assess your financial goals, budget and overall financial situation. Consider speaking to a financial planner. Don’t have one? Check out this article on what to look for in a financial advisor.