What Happens If I Pay 2 Extra Mortgage Payments a Year?
Learn how adding two extra payments to your mortgage each year can accelerate your payoff and save substantial interest. Discover methods and vital considerations.
A mortgage represents a significant financial commitment for most homeowners, often spanning decades. Many individuals seek methods to reduce this debt more quickly than the standard repayment schedule. Making additional payments beyond the required monthly amount is a common strategy employed by homeowners aiming to accelerate their mortgage payoff. This approach can lead to various financial advantages, setting the stage for increased financial flexibility.
Impact on Your Mortgage
A mortgage is typically structured using a process called amortization, where each payment includes both principal and interest. In the initial years of a loan, a larger portion of each payment is allocated to interest, with a smaller amount going towards reducing the principal balance. As the loan matures, this allocation shifts, and more of each payment begins to reduce the principal.
When an extra payment is made and specifically directed towards the principal, it directly lowers the outstanding loan balance. Since interest is calculated on the remaining principal, reducing this balance earlier means less interest accrues over the life of the loan. This accelerated principal reduction also shortens the overall repayment period. This results in an earlier payoff date, freeing the homeowner from mortgage payments years ahead of the original schedule.
Strategies for Making Extra Payments
Achieving the equivalent of two extra mortgage payments per year can be approached through several practical methods. One straightforward strategy involves making an additional full mortgage payment every six months. This means instead of 12 payments annually, you would make 14 payments.
Another method is to make one extra payment as a lump sum at the end of the year. This could come from a bonus, tax refund, or other unexpected income. By making a twelfth of your monthly payment extra each month, you will have paid one additional full payment by the end of the year.
A common strategy that naturally generates an extra payment is the bi-weekly payment plan, where you pay half your monthly amount every two weeks. This results in 26 half-payments annually, equating to 13 full monthly payments. To achieve two extra payments, you could slightly increase each bi-weekly payment or combine this method with an annual lump sum payment.
Regardless of the method chosen, it is important to explicitly instruct your lender that any extra funds are to be applied directly to the principal balance. Without this clear instruction, lenders might hold the extra money to cover future payments, which would not accelerate the loan payoff or yield interest savings.
Key Considerations
Before committing to making extra mortgage payments, it is important to review your mortgage agreement for any potential prepayment penalties. Some loan contracts may include clauses that charge a fee if a significant portion or the entire loan is paid off early, usually within the first few years. These penalties are often a percentage of the remaining balance or a certain number of months’ interest.
Understanding the role of your escrow account is also important. An escrow account is managed by your lender to cover property taxes and homeowner’s insurance premiums. Making extra payments towards your mortgage principal does not affect the amounts collected for your escrow account. The escrow portion of your payment will continue as scheduled, with adjustments based on changes in taxes or insurance premiums.
Before directing substantial funds towards your mortgage, ensuring you have an adequate emergency fund is a prudent financial practice. Financial experts generally recommend maintaining an emergency fund that covers three to six months of essential living expenses. This reserve provides a safety net for unexpected costs like medical emergencies or job loss.
Finally, it is advisable to verify with your lender how your extra payments are being applied and to request confirmation that they are indeed reducing your principal balance. Regularly reviewing your amortization schedule can also help you track the impact of your additional payments, showing how the principal balance is decreasing and the loan term is shortening.