Extra mortgage payments generally go directly to the principal, but only if you specifically instruct your lender to do so. If not designated as a "principal-only" payment, lenders might apply extra funds to interest or future payments. Ensuring these payments go to the principal reduces the total loan balance, significantly lowering interest costs over time.
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.
The key is to specify to your lender that you want your extra payments to be applied to your principal. If you don't make this clear, you may find the extra payment going toward the interest you owe rather than the principal.
The 3-7-3 Rule in mortgages isn't a loan type but a federal timeline from the TILA-RESPA Integrated Disclosure (TRID) rule, ensuring borrower protection by mandating disclosures within 3 business days of application, a 7-business-day wait between the initial Loan Estimate and closing, and another 3-day wait if significant changes (like APR) occur, giving borrowers time to review costs before committing to a loan.
These additional payments go directly towards reducing the loan principal, which is the amount you originally borrowed. By lowering the principal, you also reduce the amount of interest calculated on your loan over time. Understanding how extra repayments work starts with knowing the type of home loan you have.
To ensure extra payments go to principal, you must explicitly tell your lender through online portals, phone calls, or written notes (like the memo line on a check), often by selecting a "principal-only" or "extra payment" option and checking the box to "Do not advance due date," as lenders might otherwise apply funds to future interest or next month's payment. Setting up standing instructions or making payments the same day as your normal bill helps too, but always verify the allocation after each payment.
But if it's applied monthly, quarterly or even annually, you should aim to overpay just before. If your interest is not due to be calculated for a few months to a year, you could put your money into a high interest savings account before using it to overpay on your mortgage.
You should always prioritize paying extra toward your mortgage principal over putting extra money into your escrow account, as principal payments reduce your loan balance, save you significant interest, build equity faster, and shorten your loan term, while escrow just holds funds for taxes and insurance which you'll pay anyway. The only exception is if your escrow account has a shortage due to rising taxes or insurance; in that case, you must cover the shortage, but once current, focus extra funds on the principal.
To pay off a 25-year mortgage in 10 years, you need to make significant extra principal payments through strategies like increasing monthly payments, making bi-weekly payments (effectively one extra payment a year), applying windfalls (bonuses, refunds) as lump sums, or refinancing to a shorter term, focusing on early payments to maximize interest savings.
If you made one extra house payment a year on a $500,000 house at a 4% interest rate… Then you would pay it off in 25 years and ten months, and you would only pay $300,000 in interest. So you save four years of paying a mortgage with only one extra mortgage payment a year.
The main downsides of prepaying are tying up cash that could earn more elsewhere (like investments), potential prepayment penalties from lenders, reduced liquidity for emergencies, and missing out on the time value of money, especially if your loan interest rate is low; it also means losing potential tax deductions and can complicate financial aid.
Making an extra mortgage payment each year could reduce the term of your loan significantly. The most budget-friendly way to do this is to pay 1/12 extra each month. For example, by paying $975 each month on a $900 mortgage payment, you'll have paid the equivalent of an extra payment by the end of the year.
Suze Orman strongly advocates paying off your mortgage by retirement for financial freedom and peace of mind, but her advice on how varies by situation, often prioritizing a solid emergency fund and retirement savings first, especially if interest rates are low. While she pushes for paying down debt aggressively (even reducing retirement savings beyond the 401(k) match), she cautions against draining savings for low-interest mortgages if it leaves you vulnerable to job loss or emergencies, suggesting you should have a strong safety net before using savings to pay it off.
The main cons of paying off a mortgage early include losing the mortgage interest tax deduction, facing opportunity costs (missing higher investment returns), and reducing your financial liquidity (tying up cash in your home instead of having it accessible). You might also incur prepayment penalties (though rare on conventional loans), and it can slightly lower your credit score by removing a large, established debt, according to U.S. Bank.
What is the 50/30/20 rule? The 50/30/20 rule is a simple way to plan your budget. It suggests using 50% of your take-home pay for needs, 30% for wants, and 20% for savings and paying off debt. Typical needs include housing, transportation, insurance, childcare, utilities and groceries.
A household should allocate no more than 28% of their gross income to housing expenses. Total debt payments, including housing, should not exceed 36% of gross income under the 28/36 rule. Lenders often use the 28/36 rule to evaluate creditworthiness and loan approval.