What Happens If I Make an Extra Mortgage Payment Every Year?

An extra mortgage payment each year can significantly impact a home loan. Many homeowners aim to reduce their mortgage debt sooner than the original repayment schedule. Understanding the implications of these additional payments is important for anyone considering this strategy. This article explores the direct effects of making an extra mortgage payment, the practical steps involved, and financial considerations.

The Financial Impact of Extra Payments

Making an extra payment on a mortgage primarily targets the loan’s principal balance. Unlike regular monthly payments, which include both principal and interest components, an additional payment can be directed entirely towards reducing the outstanding principal. This direct reduction means the borrower immediately owes less on the loan.

A reduced principal balance directly leads to substantial interest savings over the life of the loan. Since mortgage interest is calculated on the remaining principal, lowering this balance means less interest accrues with each passing month. For instance, an additional $1,000 payment on a $200,000 loan at a 5% interest rate means that $1,000 less will be subject to interest calculations from that point forward. This effect compounds over time, as future interest calculations are based on an ever-decreasing principal amount.

Paying down the principal faster also shortens the overall loan term. By accelerating the principal reduction, the borrower reaches full repayment sooner than the original 15-year or 30-year schedule. This effectively “jumps ahead” on the loan’s amortization schedule, meaning that subsequent regular payments will allocate a larger portion to principal and a smaller portion to interest earlier in the loan’s life. The combined effect of interest savings and a shorter repayment period can amount to tens of thousands of dollars saved over the mortgage’s lifetime.

Methods for Making Extra Payments

Homeowners have several practical avenues for making extra mortgage payments. Most mortgage lenders facilitate additional payments through their online portals, allowing for one-time contributions or the setup of recurring extra amounts. Payments can also be made via phone, through a dedicated automated payment system, or by mailing a check directly to the servicer.

For those aiming for steady acceleration, setting up automated recurring extra payments is a common strategy. This could involve adding a fixed amount, such as an extra $50 or $100, to each monthly payment. Another method is converting to bi-weekly payments, where half of the monthly payment is made every two weeks, resulting in 26 half-payments annually, which is equivalent to 13 full monthly payments per year. This effectively adds one extra full payment each year without requiring a large lump sum.

When making any additional payment, it is important to clearly instruct the lender to apply the funds directly to the principal balance. Without specific instructions, some lenders might apply the extra funds to future scheduled payments, hold them in a suspense account, or even apply them to an escrow account for property taxes and insurance. This instruction can be provided through an online payment portal or by writing “apply to principal” on a mailed check’s memo line.

Before Making Extra Payments: What to Consider

Before committing to extra mortgage payments, homeowners should assess their loan and overall financial situation. One factor to check is whether the mortgage includes any prepayment penalties. While less common on conventional mortgages, some loan agreements, particularly older ones or certain non-qualified mortgages, might impose a fee for paying off a significant portion or the entire loan balance ahead of schedule. Reviewing the original loan documents or contacting the lender can confirm if such a penalty applies.

Establishing an emergency fund should take precedence over making extra mortgage payments. Financial experts recommend having three to six months’ worth of living expenses readily accessible in a liquid savings account. This fund provides a financial safety net for unexpected events, such such as job loss, medical emergencies, or significant home repairs, preventing the need to incur high-interest debt or access retirement funds.

Prioritizing higher-interest debts is another consideration before dedicating extra funds to a mortgage. Debts like credit card balances, personal loans, or certain auto loans typically carry higher interest rates than mortgages. Paying down these high-interest obligations first can lead to greater overall interest savings and improve financial flexibility more rapidly than accelerating mortgage payments.

Some individuals weigh the potential returns from investment alternatives against the interest rate on their mortgage. If an individual expects to earn a higher return on invested funds than their mortgage interest rate, they might choose to invest the extra cash rather than applying it to the mortgage principal. This decision involves evaluating personal risk tolerance and financial goals, as investment returns are not guaranteed.