A key rule, put forward by Martin Lewis's MoneySavingExpert, is that if your mortgage rate is close to, or higher than, a savings rate, then it is a good idea to overpay.
In general, you want to keep your mortgage with a negative real interest rate for as long as possible because inflation is paying down your mortgage for you.
But if the choice is between chipping away at your outstanding mortgage by making monthly overpayments – which reduces the amount of interest you pay – and waiting until the end of the year to bring down your mortgage balance, I would say monthly overpayments would be more beneficial.
But inflation also brings benefits to mortgage holders by reducing the value of their outstanding loans. This is key to thinking about options for providing targeted help to vulnerable borrowers.
Save on interest
Since your interest is calculated on your remaining loan balance, making additional principal payments every month will significantly reduce your interest payments over the life of the loan. By paying more principal each month, you incrementally lower the principal balance and interest charged on it.
Even one or two extra mortgage payments a year can help you make a much larger dent in your mortgage debt. This not only means you'll get rid of your mortgage faster; it also means you'll get rid of your mortgage more cheaply. A shorter loan = fewer payments = fewer interest fees.
Making extra payments of $500/month could save you $60,798 in interest over the life of the loan. You could own your house 13 years sooner than under your current payment. These calculations are tools for learning more about the mortgage process and are for educational/estimation purposes only.
Inflation allows borrowers to pay lenders back with money worth less than when it was originally borrowed, which benefits borrowers. When inflation causes higher prices, the demand for credit increases, raising interest rates, which benefits lenders.
Key takeaways
Lenders are hurt by unanticipated inflation because the money they get paid back has less purchasing power than the money they loaned out. Borrowers benefit from unanticipated inflation because the money they pay back is worth less than the money they borrowed.
Prior research suggests that inflation hits low-income households hardest for several reasons. They spend more of their income on necessities such as food, gas and rent—categories with greater-than-average inflation rates—leaving few ways to reduce spending .
This is equivalent to 12 slightly-higher monthly payments of $1,252.85 — but this small difference is enough to pay off your full debt in just 22 years and cost you only $129,712.85 in interest. In other words: two extra mortgage payments per year will save you eight years and $56,798.72 in interest.
If you pay $100 extra each month towards principal, you can cut your loan term by more than 4.5 years and reduce the interest paid by more than $26,500. If you pay $200 extra a month towards principal, you can cut your loan term by more than 8 years and reduce the interest paid by more than $44,000.
If you are under 45, it's difficult to argue that your dollars would be better served paying off your mortgage unless you are on Step 9, pre-pay low-interest debt. You should aim to be completely debt-free by retirement, and after age 45 you can begin thinking more seriously about pre-paying your mortgage.
Making additional principal payments reduces the amount of money you'll pay interest on – before it can accrue. This can knock years off your mortgage term and save you thousands of dollars.
Completing a mortgage payoff early could save you a bundle of money, not to mention years of not having a big payment hanging over your head each month, according to Dave Ramsey, financial guru, author and host of “The Dave Ramsey Show.”
“In terms of household well-being, inflation is a net boon to the middle class. The top 1% of the wealth distribution also gains handsomely from inflation. On the other hand, poor households (the bottom two quintiles in terms of wealth) get clobbered by inflation,” he wrote.
In summary: Inflation will hurt those who keep cash savings and workers with fixed wages. Inflation will benefit those with large debts who, with rising prices, find it easier to pay back their debts.
Inflationary periods are a dangerous time to add more credit card debt. Most cards have a variable APR, which means interest rates will be higher when inflation is pervasive. To avoid going further into debt, limit credit card spending wherever possible and aim to pay off your full balance every month.
Most economists now believe that low, stable, and—most important—predictable inflation is good for an economy. If inflation is low and predictable, it is easier to capture it in price-adjustment contracts and interest rates, reducing its distortionary impact.
The additional amount will reduce the principal on your mortgage, as well as the total amount of interest you will pay, and the number of payments.