What Are the Pros and Cons of Prepaying Your Mortgage?
Owning a home is a dream many people have, and it is a significant investment. Taking a mortgage allows many people to start the critical step of purchasing a home. Depending on the kind of mortgage you go for, it can become a burden for many people because of the monthly payments. You want to negotiate a mortgage that will not require that you pay for the rest of your life. You may, therefore, grapple with the question of whether or not you should make prepayments on your mortgage has a way of clearing the balance faster. However, is it a good idea?
There is no yes or no answer when it comes to mortgage prepayment. If you prepay your mortgage early, you will save a lot of money with regards to the interest you will have to pay. You get to increase the equity in your home, and best of all, you own the home sooner.
However, there are specific considerations you need to have, including whether or not you could put your money to better use elsewhere. You may, for example, settle other debts. And you could also think about saving for retirement so that you ensure that you are comfortable in the future. You may also put aside money in your emergency savings account for those situations when you may require a lot of cash upfront. If you do not have all these factors in place, you may want to rethink prepaying your mortgage. It is a decision you must only make once you have all your financial needs in place.
Understanding How the Mortgage Structure Works
You are thinking about applying for a residential mortgage, but you do not have the relevant knowledge around it. To be able to negotiate the best rates, you must take the time to understand what you are getting into. Applying for a mortgage can be tricky for most people. If you do it wrong, it could mean that you spend the rest of your life paying off the debt.
A house mortgage is a loan that you take to purchase a home. You have the principal amount, loan repayment term, and interest. You will also need to consider the taxes and insurance that may apply to the loan. Shop around for the best mortgage lender, meaning that you have to take the time to do your due diligence. You must also be ready for the lender to look into your financial background and your credit score. The best mortgage tips we could ever give you is to factor in how much money you have so that you only apply for what you can afford. You have other expenses that you need to take care of, and it would not make sense for you to take on additional obligations without having the budget in place.
Be realistic about what you can afford, and only look for a loan that you know you can service comfortably. You may have to put down an amount for the down payment, after which the lender will require that you make monthly payments, until the payoff date. The lender will give you an amortization schedule, which will provide you with a breakdown of the loan. Initially, you will be paying off the interest, and towards the end, the principal amount.
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Why Would You Want to Make Prepayments On a Mortgage?
Paying a mortgage early is a strategy many people will use to offset their loans quickly. You will accrue several benefits, which we will highlight below. Such includes the ability to save thousands of dollars in interest. You also get to eliminate long-term debt. There is also the aspect that the sooner you pay off your mortgage, the earlier you own your home.
What Is the Process of Prepaying a Mortgage?
You must understand how prepayment works. When you make prepayments on your mortgage, you get to reduce the interest you will pay over the loan term period.
When you are looking for a mortgage lender, and sure you have a good understanding of their penalties. Most will not penalize borrowers if they decide to repay their mortgage early. You must also ensure that whatever prepayment you make goes into the principal, and not the interest. If you do not let the mortgage lender know in advance that you would like the money to go to the principal amount, they may apply it to the interest. You will, therefore, be servicing the interest payments, which works for the lender but will not help you offset your loan earlier.
What Are the Advantages of Prepaying Your Mortgage?
There are several advantages to prepaying your mortgage, and we will look at them in more detail below.
You Reduce Your Loan Cost
By prepaying your mortgage, you get to reduce the total cost of the loan. If, for example, you took a loan for about $100,000 for a 30-year loan at 4%, you will need to pay $477 every month. If you decide to make an extra payment within that year and end up with 13 instead of 12 payments, you will save over $10,000 over the loan period. You also get to reduce the loan repayment term by up to four years. If you can double the payments, you can take care of the 30-year loan within 11 years. Make sure that you negotiate with the bank to put the extra payments on the principal amount so that the extras do not go to the interest. Making early payments on your interest does not mean that you will gain equity to your home faster.
You must also be careful about prepayment penalties, and must, therefore, be very clear about this before you start making any prepayment.
It Will Affect Your Taxes and Interest
The advantage of prepaying your mortgage is that you will receive tax breaks. If you pay it off entirely, the same does not apply. You, however, get to benefit from paying less interest on what you would eventually spend on the final loan. It would, therefore, make more sense to pay off your loan early. It is doubtful whether the tax incentives would outweigh the benefit of paying less interest.
You Get to Pay Off Your Loan Sooner (And Save on Interest)
Prepaying your mortgage will mean that you get to reduce the time you will need to pay off the loan. You also get to ensure that you have better cash flow in the future. If you have a young family, you will have many concerns among them being able to pay school fees, college fees tuition, among others. You are, therefore, better off facing these years without having the burden of mortgage payments as well. What you will enjoy is the peace of mind, and an ability to handle your financial obligations more comfortably.
It Helps Build Home Equity Faster
You calculate your home equity by subtracting what you owe on the loan, from the market value of your home. If, for example, the market value of your home is $500000, your mortgage balance is $300,000, then the equity in your home is only $200,000. You therefor get to increase your home equity by reducing the mortgage balance, which you can hasten by making larger payments. The best thing about having home equity is that you can use it to apply for a home equity line of credit or loan.
It Will Impact On Your Credit Score
If you have less debt and can make your monthly payments, it will help improve your credit score. Credit reference Bureaus will base your credit score on your ability to handle your financial obligations. Showing that you can comfortably make mortgage payments is, therefore, a fantastic way to raise your credit score. A good credit score is essential, especially if you hope to apply for loans in the future. Moneylenders will want to know whether you are capable of making payments, and one way of knowing is by looking at your credit score.
Prepaying Your Mortgage Is a Good Option If You Are a Poor Saver
Different people will handle money in different ways. For some, immediately they receive the money they will run to the bank and save it for some future projects. And for others, the money will go into investment options. For some, it will go towards settling debts or paying off certain financial obligations.
Yet, some people receive cash and immediately go on a shopping spree, and within no time, they will have nothing remaining. If you are someone who is not capable of saving, then prepaying your mortgage may be the best option. You are better off spending the cash, reducing your principal mortgage amount instead of wasting it on frivolous activities.
Disadvantages of Prepaying Your Mortgage
But let’s look at the flip side as well. As with anything, prepaying your mortgage and answer to the question “Should you do it?” is not all black and white. Here are some disadvantages you should know about if you are thinking about paying off your mortgage earlier.
You May Incur Penalties
We have already talked about lenders who will impose a penalty if you make your mortgage payments early. We would, therefore, recommend that you take the time to read the documents properly before you sign up for a house mortgage. You will avoid any issues concerning the notice.
You Lose Out On the Tax Deductible Benefits
When you prepay your loan, you reduce your mortgage interest. You will note that any payments you make towards your loan in the initial stages go towards paying off the interest. If we are to go back to the example above of mortgage for $300,000 over 30 years at 4% interest. You could deduct $10,920 in tax benefits.
However, the law now requires that you itemize your deductions, which may be an inconvenience for many homeowners. The standard deduction is $12,200, $18,350, and $24,400 for individuals, heads of households, and couples who are filing jointly, respectively. After 2017, you could only deduct interest on the first $750000, while in the preceding years, you could do it for up to 1 million dollars.
You May Lack Money to Invest in Other Projects
Prepaying your mortgage means that you do not have money left over for investing in other Ventures. You could lose fantastic opportunities in things such as real estate investment trusts, stocks, bonds, among others. Talk to your financial advisor about where you can put your extra money so that you get better financial Returns. It will also depend on your financial risk Tolerance levels.
You May Be Better Off Paying Higher Interest Debts
Instead of prepaying your mortgage, you may want to think about paying off higher interest debts. You may, for example, have student loans or credit card loans that attract very high-interest rates. It would make more financial sense to pay off such, and then make prepayments on a mortgage only when you have the financial capacity to do so.
You May Ignore Other Financial Goals
Other than investing or paying off high-interest debts, there are many other financial goals many individuals have. One such purpose is ensuring that you have retirement savings, which will help you live a more comfortable life, once you leave formal employment.
You must also ensure that you have emergency funds that can cover up to six months of your bare living essentials.
How Do You Make the Decision On Whether to Prepay Your Mortgage?
As we have already seen above, deciding on whether to prepay your mortgage is a weighty one. You must weigh the savings vs. opportunities, as well as determining the best places to use the available money. You must also have a good understanding of your credit profile and your ability to make more money in the future. Other things to consider include exposure to inflation, lost tax benefits, the returns you will forgo on investments, among others.
Prepaying your mortgage means that you can comfortably take care of your financial obligations. You must also save, put something aside for the emergency fund as well as towards your retirement years. You can build home equity by reducing the mortgage amount. If, however, you need cash quickly, turning your home into money may be more complicated than you could anticipate. The value of your home also depends on the market, and in times of market volatility, the value of your home may be lower. What you may have bought for $200,000 could at a particular time cost as low as $100,000.
How to Pay Off Your Mortgage Early
Paying off your mortgage early is a great accomplishment because it gives you a level of financial independence. It allows you to plan for your money without having to worry about mortgage payments. However, it ties up your cash, and you are not able to put it on other areas, which would give you higher Returns.
Many financial advisors are wary about telling their clients to settle the mortgage early. They feel you are better off putting your money to better use elsewhere. You do, however, need financial discipline to be able to realize your financial goals. There are times you will have to make some sacrifices so that you get to keep a large part of your income.
Your age will also determine what kind of decision you make with regards to prepaying your mortgage. If you are young and have the potential to earn money over a long time, you should think about aggressively investing the money. However, if you are close to retirement age, it would make more sense for you to pay off the mortgage. So how can you pay off your mortgage early?
Think About Refinancing to Shorter-Term Loans
You can refinance a 30-year loan to 10 or 15 years. You must, however, factor in that your monthly payments will be more, unless, you can negotiate for lower interest rates.
Reconfigure Your Payments
Looking for mortgage refinancing is not always the best option. Talk to your financial lender to help you reconfigure the payments to lower terms. Look at the various time frames and how they could impact your monthly payments. Think about the penalties, and channel your money to paying off the principal.
Pay A Bit More or Add an Extra Payment
You have the option of adding a little more money to your monthly payments. You could also look at the year as having 13 months instead of 12 so that you make one extra payment every year.
You can opt to make a lump sum payment towards the principal amount anytime you have some extra cash. It will help you reduce the loan term, and you must keep a close watch on the payoff date.
Factors to Consider If You Want to Pay Off the House Mortgage Faster
There are several factors you need to consider when thinking of paying off the house mortgage quickly, and these include: –
- Understand what you owe, and how much interest you will pay
- Set goals of paying off the mortgage faster, and work towards it. Setting financial goals is vital because it helps you determine better use for your money
- Consider the interest rates you pay for all your that’s including credit cards, among others.
- Think about paying the high-interest rate loans first before prepaying your mortgage
- If you can afford it, make weekly or bi-weekly payments instead of monthly. It will allow you to make a full extra payment every year thereby enabling you to pay off the mortgage faster
- If you have some extra money, consider making lump payments on the principal
Mistakes to Avoid When Taking a Mortgage
There are several costly mistakes one can make when taking a mortgage. These include: –
Committing Too Much to The Mortgage Payments
The typical household has very many home related costs that you must meet before investing your money to mortgage payments. It could be tuition, replacing your car, shopping for groceries, among others. You must contain your expenditure to less than 28% of your pre-tax income. It will then determine how much you can put aside for your mortgage payments.
Not Understanding What It Means to Own a Home
There are so many other costs you will incur from owning a home that it may come as a surprise to you as a new homeowner. Routine maintenance will take up to 2% of your home purchase price. While this does not apply to every year, the costs may vary, whether upwards or downwards. You may, for example, need to replace the roof, fix the furnace, install a new water heater system, among others. The amount you spend on Renovations will depend on how old the house is. You will also need to factor in property taxes insurance, among others. You must factor in these costs when you are budgeting for the mortgage prepayment.
Taking The First Loan Offer That Comes Your Way
We cannot emphasize this enough; you must shop around for the best lender when you are thinking of applying for a mortgage. You must also pay attention to any other fees that may accompany the loan amount you receive. There are some hidden costs that you will only discover once you have put your signature on the dotted line. Talk to someone who has a good understanding of mortgages, even if it requires that you set aside some money to pay a financial advisor.
Find a reputable lender, an open and honest one, with whom you can communicate all your questions and concerns. Open communication is extremely important, and you need to trust your lender that they are telling you everything you need to know. If you’re interested in getting offers, please fill out the form below:
Not Paying Attention to APR
We all know that lenders like to hype the fact that they are offering very low-interest rates. What does not accompany the marketing language is the fact that you will end up paying high fees in other areas. Do a comparison of the annual percentage rates (APR) because it will show you the actual cost of your loan. It will take into consideration the principal amount, interest, origination fees, and closing costs, among others.
Not Paying Attention to Your Credit Report
It is interesting to note that few people pay attention to their credit reports. Yet, you can get your credit report from the credit Bureaus or even online. You must spend time checking your report and correct any issues before you apply for a mortgage. The lender may reject you, and a bad report will stay on your credit score for a long time.
Not Paying Attention to Your Down Payment
Most lenders will require that you make a down payment before they disperse the final loan amount to you. You must, therefore, look for a way to finance it, if you do not already have sufficient savings to take care of this cost.
Not Insuring the Mortgage
You must take insurance for the loan you receive for your home so that if anything happens to you, you do not leave your family in financial Straits. Your family will get monetary benefits if you take life insurance. It also protects them from inheriting the loan if you die. Other policies, such as critical illness insurance, will assume liability if you are not able to make payments due to significant illness.
Floating Vs. Fixed-Rate Loans
If you take a floating rate loan, you will pay varying interest amounts depending on the market situation. Sometimes you may pay a lower amount other times; it may be higher. Fixed-rate loans, on the other hand, are fixed and will not fluctuate. From the beginning, you know how much you pay every month, thus allowing you to budget better.
Not Paying Attention to The Penalties
It all goes back to reading the fine print before you sign on the dotted line. There are specific penalties you face, as we have already stated above, including the payment or lump sum penalties. In other situations, if you’re not able to make the payments, a bank can employ specific recovery strategies to get back their money. It is not uncommon for clients to complain about very harsh treatment from specific lenders, anytime they were not able to pay back the amounts on time.
Ignoring Customer Reviews
Reading customer reviews and even talking to some customers can help you avoid a bad lender. Carefully read and listen to what they have to say so that you know what to expect.
Buying a home is an essential component because, quite honestly, no one wants to pay rent for the rest of their lives. You must, however, take the time to shop around for a suitable lender who will give you the best mortgage rates available. Prepaying your mortgage allows you to get rid of the debt burden early, but there are specific considerations you must have.
We have looked at the advantages and disadvantages of paying off your mortgage early. We have also shared with you mistakes to avoid when taking a mortgage. The most critical thing to do is to understand the mortgage structure. You must not tie up your money because you could be putting it to other uses, such as paying off high-interest rate debts. You must also ensure that you save for retirement, as well as set aside something in your emergency fund. Before making any financial obligations, you must talk to a financial expert to guide you through the process.
About the Author – jamie a
Ethan founded Goalry, Inc in Dec 2016 with the mission to build the world’s first and only Financial Goal Mall. One place to reach financial goals and comparison shop for any money matter. Taub invents the IP for the finance stores within the mall, while overseeing various aspects of the company. He also has orchestrated the company’s earned media across the finance stores: Accury®, Billry®, Budgetry®, Debtry®, Cashry®, Creditry®, Loanry®, Taxry® and Wealthry®. This includes over 1200 blogs, 400 videos, thousands of social post and publications that have been featured across the web.