Should I Make an Extra Mortgage Payment?

Making an extra mortgage payment means sending additional funds to your lender beyond your regular monthly amount. These extra funds are applied directly to the loan’s principal balance, influencing your overall financial situation. Understanding this strategy and its implications is important for homeowners.

Understanding the Financial Impact

Applying additional funds directly to your mortgage principal can significantly reduce the total interest paid over the loan’s life. Mortgage loans are structured so that a larger portion of early payments goes towards interest, with less applied to the principal. By reducing the principal balance sooner, you decrease the amount on which future interest is calculated. This accelerated principal reduction also shortens the overall loan term. For example, consistently adding $50 or $100 to your monthly payment, or making one extra full payment each year, can shave years off a typical 30-year mortgage.

Key Considerations for Your Decision

Before making extra mortgage payments, establish a financial foundation. Maintain an emergency fund covering three to six months of living expenses, offering a safety net for unexpected events like job loss or medical emergencies. This fund prevents incurring high-interest debt if unforeseen circumstances arise.

Evaluate other outstanding debts. High-interest debts, like credit card balances with APRs from 18% to 30% or more, warrant accelerated repayment before focusing on a mortgage. Savings from eliminating these debts typically outweigh interest savings from an extra mortgage payment, especially since mortgage interest rates are often lower, perhaps 4% to 8%.

Consider opportunity cost: weighing potential returns of alternative uses for your money. Investing in a diversified portfolio might offer a higher potential return than your mortgage interest rate, though investment returns are not guaranteed. Historically, the stock market has provided average annual returns of 7% to 10%, but these returns come with market risk. Conversely, reducing mortgage interest offers a guaranteed return equal to your mortgage interest rate.

Align extra mortgage payments with your financial goals. For those nearing retirement, reducing housing debt might be a primary objective to lower fixed expenses. Younger individuals might prioritize saving for a child’s education, contributing to a retirement account, or accumulating a down payment for a future investment property. The decision should reflect your individual circumstances and long-term financial objectives.

Methods for Making Extra Payments

Several approaches exist for making extra mortgage payments. One method involves sending an additional full principal payment each year, achieved by dividing your regular monthly payment by 12 and adding that amount monthly. This results in 13 payments annually. Alternatively, round up your monthly payment by a fixed amount, such as an extra $50 or $100.

Another strategy is bi-weekly payments, making half your monthly payment every two weeks. This results in 26 half-payments annually, totaling 13 full monthly payments. This method accelerates principal reduction without a large lump sum. Financial windfalls like bonuses, tax refunds, or inheritances can also be applied directly to your mortgage principal to significantly reduce your loan balance.

Regardless of the method, clearly instruct your mortgage servicer to apply extra funds solely to the principal balance. Without explicit instructions, additional payments might be held and applied to your next month’s regular payment or an escrow account, which would not accelerate your loan payoff. Contacting your servicer directly ensures your extra payment is correctly allocated.

Impact on Escrow and Property Taxes

Extra mortgage payments do not affect your escrow account balance or amounts for property taxes and homeowner’s insurance. The escrow account is a separate component, managed by your servicer to cover annual expenses. Funds collected are held in a trust account and disbursed when property tax bills and insurance premiums are due.

Property tax amounts are determined by local authorities based on assessed values and rates; homeowner’s insurance premiums are set by your provider. These amounts are independent of your mortgage principal. Reducing your principal shortens the loan term and decreases interest paid, but it does not alter underlying tax assessments or insurance costs.

Your mortgage servicer reviews your escrow account annually to adjust your monthly escrow payment based on changes in property taxes or insurance premiums. These adjustments ensure sufficient funds are collected for anticipated costs. The escrow portion of your payment will still fluctuate based on external factors like property valuation and insurance market conditions.