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.
With an extra payment each year, you can pay your principal down faster than you would with the monthly payment strategy. While you'll be making an extra payment, you likely won't feel a negative financial impact because the payments will be spread throughout the whole year.
When you make an extra payment or a payment that's larger than the required payment, you can designate that the extra funds be applied to principal. Because interest is calculated against the principal balance, paying down the principal in less time on your mortgage reduces the interest you'll pay.
By applying the overpayment to your principal, you can reduce the amount of interest calculated on each month's principal balance. The more quickly your principal balance is reduced, the faster your interest costs will fall. Over 20 to 30 years, you can save thousands of dollars in interest costs.
Some mortgages allow you to overpay as much as you want, but others limit overpayments to a percentage of the amount you owe. On many mortgages, this maximum limit is 10% of the outstanding balance per year. Bear in mind that you could be charged a penalty fee if you overpay by more than the allowed limit.
Tip #1: Make Overpayments
For example, if your monthly mortgage payment is £1,000, consider increasing it to £1,200. This extra £200 will go directly towards paying off your mortgage faster. This extra payment goes directly towards paying off the principal, which is the amount of money you borrowed to buy your home.
Rather than delaying credit until the next month, the optimal day within the month to make an extra payment is the last day on which the lender will credit you for the current month.
When you make a lump-sum payment on your mortgage, your lender usually applies it to your principal. In other words, your mortgage balance will go down, but your payment amount and due dates won't change.
The 2% rule states that you should aim for a 2% lower interest rate in order to ensure that the savings generated by your new loan will offset the cost refinancing, provided you've lived in your home for two years and plan to stay for at least two more.
Make One Extra Payment Per Year: One way of paying off your mortgage earlier than the term of your mortgage is to make 13 payments per year instead of 12. You can add in the extra payment whenever you want throughout the year and continue to make those regular monthly payments as well.
In some cases, a prepayment penalty could apply if you pay off a large amount of your mortgage all at once. Prepayment penalties do not normally apply if you pay extra principal on your mortgage in small chunks at a time–but it's always a good idea to double check with the lender.
Generally, 'closed' mortgages have an annual prepayment privilege maximum of 15-20% of the initial mortgage balance. For example, for an initial total loan amount of $300,000, a 20% annual prepayment privilege would mean you can prepay up to an extra $60,000 per year without penalty.
Faster Loan Payoff
By making 2 additional principal payments each year, you'll pay off your loan significantly faster: Without extra payments: 30 years. With 2 extra payments per year: About 24 years and 7 months.
What happens to my mortgage if I make one extra payment a year? Making an extra payment to your mortgage each year will reduce the length of your repayment by several years — generally between four and six years. It will also lower the amount you pay in interest over time and help you build home equity more quickly.
It suggests that homeowners who can afford substantial extra payments can pay off a 30-year mortgage in 15 years by making a weekly extra payment, equal to 10% of their monthly mortgage payment, toward the principal.
Ideally, you want your extra payments to go towards the principal amount. However, many lenders will apply the extra payments to any interest accrued since your last payment and then apply anything left over to the principal amount. Other times, lenders may apply extra funds to next month's payment.
Deciding on a set amount you are going to overpay regularly could help you budget. And if things change you can stop at any time. A lump sum could save you money on interest and clear your mortgage faster, but you won't be able to get your hands on the money once you've paid it over.
Let's say you currently owe $200,000 on your mortgage and you want to pay it off in 5 years or 60 months. In this case, you'll need to increase your payments to about $3,400 per month.
Your lender or servicer allows biweekly mortgage payments. Your extra payments are applied to the loan principal. You won't be charged a prepayment penalty or fees for setting up or maintaining the payment plan. Your interest rate won't change (unless you have an adjustable-rate loan).
Early Mortgage Payoff Examples
If you paid an extra $500 per month, you'd save around $153,000 over the full loan term and it would result in a full payoff after about 21 years and three months.
Typically, comps in a certain area will fall within the same price range. If the house you're thinking of placing an offer on is priced significantly higher than a similar home on the same block or in the larger neighborhood, it could mean the house is overpriced.
There is no specific age to pay off your mortgage, but a common rule of thumb is to be debt-free by your early to mid-60s. It may make sense to do so if you're retiring within the next few years and have the cash to pay off your mortgage, particularly if your money is in a low-interest savings account.