Prepayments on loans and mortgages typically go directly toward the principal balance. By reducing the principal, you owe less interest over time and can pay off the loan faster. It is important to confirm with your lender that extra payments are designated as "principal-only" rather than prepaying future interest or installments.
You can make lump-sum payments to pay down your mortgage faster. To avoid prepayment charges, your payment cannot exceed your allowable prepayment privilege. A lump-sum payment is applied directly to the principal if there's no interest owing. This saves you money over the life of your mortgage.
Home loan prepayment means paying an amount over your regular EMI (Equated Monthly Instalment) toward the outstanding principal. This additional payment directly reduces the principal, lowering the interest charged on subsequent EMIs.
This extra payment may be applied directly to your principal balance. Be sure to first check with your lender if this is an option for your loan.
Make Overpayments Regularly
One effective way to pay off your mortgage faster is by making overpayments. Essentially, this means paying more than the standard monthly amount. Even small additional payments can reduce the interest you owe and shorten your mortgage term over time.
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.
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.
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.
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.
There are upsides to making prepayments on a mortgage… By making payments earlier than required, you are saving on the interest the mortgage is costing you. The sooner you pay off your loan, the sooner you can stop making monthly payments with interest. Interest you save on a mortgage can be tax-deductible.
A 5-4-3-2-1 prepayment penalty, otherwise known as a 5 year stepdown prepayment penalty, charges a 5% fee on the outstanding principal loan balance if the loan is paid off in year 1, a 4% fee in year 2, a 3% fee in year 3, a 2% fee in year 4, and a 1% fee in year 5.
Negotiate better:
If you have a better CIBIL score, use it for your benefit. With a better CIBIL score, you can negotiate better with the lender on the loan terms. You can ask for a better interest rate and a loan free of prepayment penalty. Most banks have a limit of 12 EMIs, after which you can close the loan early.
Contact your lender.
Sometimes lenders automatically apply extra payments to the next month's payment rather than toward the principal. To avoid this, contact your lender and specify that you want any extra payment to go straight to the principal balance.
If your 25% tax-free lump sum doesn't cover your outstanding mortgage, making a taxable withdrawal to pay it off in full probably won't make financial sense as it would trigger a range of additional tax considerations.
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.
Making payments directly to the principal normally reduces the amount of interest paid because interest is calculated as a percentage of the principal. Typically, the lower the principal, the less interest owed.
Early repayment may temporarily lower a credit score due to changes in payment history and credit mix. Prepayment penalties can offset savings from early loan repayment, so it's important to check for these. On-time payments and low credit utilization help recover any temporary credit score dip.
“Paying off your mortgage early seems impossible but it is completely doable and people do it all the time, but how can you do it and why would you want to put in the extra effort? Paying off your mortgage early will rev up your wealth building.”
If your mortgage rate is higher or similar to the savings rate you're looking at, overpaying your mortgage is likely to make greater financial sense. If the savings rate is higher than your mortgage rate, it might be better to prioritise saving for the future.