Some home-owners choose to make extra payments on their mortgage in order to pay off their debt faster. Is this a good idea or not? What are the drawbacks and benefits of paying off your mortgage faster?
The Down Side Of Extra Mortgage Payments
We often advise our clients not to have mortgage payments that are more than a quarter of their take-home pay. This is because unexpected expenses of the loss of income put these folks at risk of defaulting on their loan. The best approach is to have a mortgage payment that is manageable and to put a sum of money aside for up to six months of expenses, including mortgage payments. If you choose to pay ahead of your mortgage that is generally a good thing. But do not start prepayment on your mortgage if it leaves you with nothing left over for emergencies. But, once you have put a little aside and more sure that how much you are paying ahead on your mortgage is not causing problems elsewhere in your finances, what are the benefits?
The Up Side Of Paying Off Your Mortgage Faster
The ultimate goal of making extra payments on your mortgage is to pay off your debt faster. It is a happy day for any homeowner when they make their last mortgage payment. But, even if you have not paid off your loan by the time you want to sell and purchase another home, you will have greatly increased your equity in your home. How does this work?
It’s all about the interest payments. The reason that a 30-year mortgage cost so much more in the long run than a 15-year is that the borrower is paying interest for so many more years. When a really long-term mortgage starts out, almost all of the mortgage payment goes to pay the interest on the debt and very little goes to reduce the principal, the amount you still owe the lender.
Every payment on principal reduces your debt so that the next payment includes just a little less for interest and a little more toward the principal. The idea of paying off your mortgage faster is to move to a point where you are paying off the principal faster and therefore driving down the interest payments more and more with every payment. Because the mortgage payment is always the same amount, a lower interest payment leaves room for more of your payment to go towards your debt. The more early payments you make the faster this happens and the faster your equity increases in your home.
Simply making an extra payment every quarter can get your mortgage paid off years early. In fact, you can accomplish some of the same by simply splitting your payments and making half the mortgage payment two weeks early and the other half at the usual time. That little bit of early payment still reduces your principle slightly earlier than the normal schedule and thus the second half-payment is a little more for debt and a little less for interest. This approach is not as fast a way to accelerate your mortgage payments but it largely pretty pain-free