Is Prepaying Your Mortgage A Good Decision?

Images by GettyImages; Illustration by Hunter Newton/Bankrate

When you take out a mortgage, you’re typically agreeing to pay it back over multiple decades — but that doesn’t mean you can’t pay it off sooner. Here’s a look at how to prepay your mortgage, the benefits and drawbacks and how much you could save.

How does prepaying my mortgage work?

Prepaying a mortgage simply means paying off your loan early.

Normally, when you pay your mortgage each month, you send a specific amount to your mortgage servicer. That regular mortgage payment includes all the components of PITI, which stands for principal, interest, taxes and insurance. When you pay extra on a mortgage, you pay more money toward your principal than is required by your original loan agreement.

Additional mortgage payment calculator

Use our additional payment calculator to estimate how making extra payments will affect your mortgage.

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4 ways to prepay a mortgage

1. One extra payment once a year
2. Biweekly payments
3. Additional payments at your discretion
4. Recasting

Let’s say you take out a standard 30-year mortgage of $400,000 at a 6.8% interest rate. The monthly mortgage principal and interest total $2,608. Here’s what happens if you make extra mortgage payments:

Whichever method — or combination of methods — you choose, make sure your servicer applies the extra payments to the loan principal. If you don’t specify, the additional money will go toward your next monthly mortgage payment instead, paying both principal and interest. This will still help you pay off your loan faster and save on interest, but not as much as making a payment toward the principal.

One extra payment

You can prepay your mortgage by making an extra monthly payment once a year, or 13 payments in a 12-month period. Using the same example mortgage, this amounts to over $125,000 in interest costs saved. This can be done as a lump sum once a year or through biweekly payments.

Biweekly payments

You can also choose to make one extra payment each year with biweekly mortgage payments. In this method, you split your monthly payment in half and pay one half every two weeks. Over the course of a year, you’ll make 26 payments, which equals 13 monthly payments.

Additional payments

You can pay more toward your loan principal at any time. Some borrowers do this with windfalls, such as an unexpected bonus or inheritance. Others make smaller extra payments regularly if their monthly budget allows. Even an extra $50 or $100 toward your mortgage every month can drastically cut down on the total amount of interest you pay.

Recast your mortgage

If you have a lump sum available to put toward your mortgage — often at least $10,000 — consider recasting your loan. For a fee, your lender will amortize your loan with a new payment schedule. Your loan term will stay the same, but you’ll have less to pay back. Plus, you’ll keep the same mortgage rate — a big potential benefit over refinancing, which might lock you into a higher one. Keep in mind that some lenders don’t offer recasting.

If yours does, however, you could save a lot of money. Say you have that $400,000 mortgage at a 6.8% interest rate, and 10 years in, you receive a $75,000 inheritance. If you apply all $75,000 to your existing balance — $336,834 — you’ll reduce your monthly payment to $1,998.68. Your future interest payments will also be based on that smaller amount.

Pros and cons of paying additional principal on your mortgage

Pros

• Save significant money on interest.
• Pay your mortgage off sooner.
• Build equity in your home faster.
• Reduce your debt-to-income (DTI) ratio, which can make it easier to get other loans.
• Get rid of private mortgage insurance (PMI) faster, if you’re currently paying for it.

Cons

• Less money for saving, investing or other financial goals.
• Ties up money in home, where it isn’t as easily accessible.
• Smaller mortgage interest deduction.
• Possible prepayment penalty.

Here are some reasons to consider paying off your mortgage ahead of schedule:

• You want to save on interest: By making extra principal payments, you’ll shorten the time it takes to repay the loan, saving money on interest.
• You plan to sell your home soon: Paying off your mortgage early builds equity in your home more quickly. That means you’ll pocket more of the proceeds when you sell.
• You prefer less debt: Even though a mortgage is largely considered “good debt,” you might want to pay it off for peace of mind. Doing so eliminates any risk of defaulting on the loan if your situation changes in the future.
• You’re getting ready to retire: If you’re approaching retirement and expect a decrease in income, paying extra on your mortgage now could help you prepare.

Questions to ask yourself before paying extra on your mortgage

When deciding whether to pay extra on a mortgage, look at your entire financial picture. Here are some important questions to consider:

• Is your monthly budget already tight? If so, you might not want to put your limited discretionary funds toward your mortgage, a relatively inexpensive loan.
• Is your income variable or unpredictable? Consider saving any extra funds for the times when you don’t have as much coming in.
• Are you close to paying off your loan? If you have a low balance on your mortgage, it might make sense to keep your payments as-is and invest extra funds elsewhere.
• Do you have an adequate emergency savings fund? If not, focus on building these savings first — at least three to six months’ worth of expenses.
• Are you saving enough for retirement? If you’re not sure if you’re saving enough, use our retirement calculator.
• Do you have credit card balances or other loans with higher interest rates? Because mortgages aren’t as expensive as other forms of debt, it often makes more sense to pay off credit cards or other loan balances before your home loan.
• Could your money get a higher return elsewhere? Depending on when you took out your mortgage, you may be paying a fairly low interest rate, potentially 4% or less. Assuming you invest extra money at a higher rate of return, your money might work harder for you in the market than by eliminating your mortgage.

If you answered yes to any of these questions, it might be better to hold off on prepaying your mortgage.

That said, “If it fits into your budget, you want to get rid of the debt, and you’re in good shape with other savings or investing goals, make extra payments on your mortgage,” says Linda Bell, senior writer at Bankrate. “Every additional dollar shaves time off your loan and saves you interest.”

FAQ

• Are there tax implications associated with prepaying my mortgage?
  

  Once you fully pay off your mortgage, you’ll lose the mortgage interest tax deduction. If you itemize your taxes, and the deduction is an important savings tool for you, talk to a CPA before paying extra on your mortgage.

• Does prepaying my mortgage affect my credit score?
  

  Prepaying your mortgage won’t have a direct impact on your credit score. However, as you pay off more of your loan, your balance will shrink, and your credit utilization ratio will change. This factor does affect your score.

• Are there any limitations on how much I can prepay on my mortgage?
  

  Not usually. You can prepay as much as you’d like, or pay off your loan completely, at any time.

• Can I skip a regular payment if I’ve made additional prepayments?
  

  No. You must still make your scheduled monthly payments until you’ve paid off the loan in full.