When you receive your mortgage statement each month, you may have noticed the option to pay more than your required monthly payment. As you pay down your mortgage balance, your monthly payment won’t decrease like a credit card payment would – so why pay extra?
There are three main perks of paying additional principal. First, you will pay less interest over the life of your loan. For example, let’s say you have a 30-year fixed-rate mortgage in which you borrowed $200,000 at a 4 percent interest rate. After 30 years, you will have paid $143,739 in interest on top of the principal borrowed. If you were to make one extra mortgage payment on a yearly basis, you would save $21,616 over the 30 year period.
In addition to saving a substantial amount in interest, another benefit is shaving years off of your loan. Using the same example from above, by paying one extra payment yearly, you shorten your loan by nearly four years.
Lastly, you gain equity in your home at a faster pace. In the beginning years of your mortgage, the majority of your monthly payments are going toward interest. Think of your additional principal payment as a supplementary deposit in your savings account. If you need to tap into your equity in the future, there will be a larger amount there than if you had only paid your minimum 12 monthly payments.
Ways to Pay Additional
The strategy you choose to take in paying your principal down on your mortgage should reflect how you tend to manage your finances. Here are three ways to pay additional principal:
- Bi-weekly approach – in essence, making half of your mortgage payment every two weeks, or 26 times a year, will add up to an additional yearly payment.
- Increase your monthly payment – if your goal is to add one additional mortgage each year, divide your monthly payment by 12 and tack that onto your normal monthly payment.
- Pay an extra payment once a year – if you get an annual bonus or generally receive a sizable tax refund, this approach might be right for you by allowing you to make a one-time additional principal payment.
Additional payments can be a good route for many homeowners, pending the amount of time they plan to stay in their home, other monthly debts, retirement funds, etc. Paying in additional principal is not always the best financial choice for everyone. Talk to your accountant or mortgage banker to see how it fits into your finances.
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