What Happens If You Make 1 Extra Mortgage Payment a Year?

A mortgage represents a significant financial commitment, often spanning decades. Homeowners typically make consistent monthly payments over the loan’s term, which can be 15, 20, or 30 years. Understanding how these payments are applied and how even slight adjustments can influence the overall loan trajectory can be beneficial for managing this long-term obligation.

The Impact on Your Mortgage

Mortgage payments are structured to gradually reduce the loan balance through a process called amortization. Early in the loan’s life, a substantial portion of each payment goes toward interest, with a smaller amount applied to the principal balance. As time progresses and the principal decreases, a larger share of the payment then shifts to reducing the principal.

Making an additional mortgage payment each year impacts amortization. When extra funds are applied to the principal, the loan amount is reduced faster. Since interest is calculated on the remaining principal balance, lowering this balance lessens interest accrued. This accelerates principal reduction, leading to two advantages: less total interest paid and a shorter loan term. For instance, on a typical 30-year mortgage, making one extra payment annually can shave off several years, often ranging from four to eight years, and result in thousands of dollars in interest savings.

For example, on a $300,000 mortgage at a 6.75% interest rate, a monthly payment might be just under $2,000. By making one extra payment per year, the loan term could be reduced by approximately six years, leading to significant interest savings over the full life of the mortgage. Even smaller additional contributions, such as an extra $50 per month, can lead to substantial interest savings, potentially cutting the loan term by more than two years. This strategy effectively compounds savings over time, as less interest accrues on a continuously shrinking principal.

Structuring and Making Additional Payments

Several approaches exist for making an extra mortgage payment each year. One common method involves dividing your monthly payment by twelve and adding that amount to each monthly payment, resulting in one extra full payment annually. Alternatively, a homeowner might choose to make a single lump-sum payment once a year, perhaps using a tax refund, bonus, or other unexpected funds.

Making bi-weekly payments is a popular strategy that achieves the same outcome. Instead of one monthly payment, you pay half of your monthly amount every two weeks. Since there are 52 weeks in a year, this results in 26 half-payments, which equates to 13 full monthly payments annually. This effectively adds one full payment to the principal each year without a noticeable increase in cash outflow.

Regardless of the method, ensure additional funds are designated for the loan’s principal balance. If not specified, lenders might apply extra payments to the next month’s regular payment, hold them in an unapplied funds account, or allocate them to an escrow account, rather than reducing the principal. Most mortgage servicers offer options through online portals to specify principal-only payments, but a direct phone call or a clear written instruction with a mailed check can also ensure proper application. Confirming with the lender that extra funds reduce the principal is necessary to realize benefits.

Key Considerations for Extra Payments

Before committing to an extra payment strategy, review mortgage terms for prepayment penalties. While less common on recent conventional mortgages, some loan agreements may include clauses that charge a fee for paying off a significant portion of the loan early. Federal regulations limit these penalties to the first three years of a loan, with caps from 1% to 2% of the outstanding balance. However, making smaller, consistent additional principal payments typically does not trigger these penalties.

Consider the impact on escrow accounts. Many mortgage payments include amounts for property taxes and homeowner’s insurance, held in an escrow account by the lender. Extra principal payments do not directly affect the escrow portion. It is important to ensure your escrow account remains adequately funded to cover these obligations, as a shortage could lead to an increase in your monthly payment or a required lump-sum payment.

Reducing mortgage principal faster means less total interest paid over the loan’s life. This can slightly reduce the mortgage interest deductible on federal income taxes if itemizing. For mortgages originated after December 15, 2017, the deduction limit applies to interest paid on up to $750,000 of qualified mortgage debt. Even with this potential reduction in tax deduction, the overall financial benefit of saving many thousands of dollars in interest typically outweighs the reduced tax benefit.

Consider overall financial priorities before dedicating funds to extra mortgage payments. Maintaining an adequate emergency fund (three to six months of living expenses) is a foundational step. Addressing high-interest debt, such as credit card balances, often yields a greater financial return than accelerating mortgage payments due to higher interest rates. Ensuring retirement savings are on track and maximizing employer-matched contributions should also precede an aggressive payoff strategy.