A mortgage is one of the single debts you are likely to willingly take on. As such, being able to manage your mortgage is very crucial. With so many options when it comes to loans, repayment and refinancing, it can all get a bit complex. One point in particular that you may hear a lot of talk about is prepaying your mortgage.
What happens if you prepay your mortgage? If you focus on other things first? Prior to rushing into prepayment, make sure you have all of the information first. We’ll start by looking at exactly what mortgage prepayment is and the way it works.
What Is Mortgage Prepayment?
As the name implies, mortgage prepayment is the act of paying some or all of your mortgage principal before it’s actually due. This can take on an assortment of forms, from paying a higher amount than the actual payment that’s due each month to making additional payments in months where you have money to spare.
Some homeowners even make a single large additional payment each year after getting a tax return. Regardless of the specific form that prepayment takes, the final result is the same: More of your outstanding mortgage balance gets paid off, leading to a reduction in both the amount that you still owe and the amount that interest can be applied to.
What Are the Benefits of Prepaying?
There are several benefits to prepaying your mortgage, regardless of how often the payments are made. Think about the following and how they might apply to your mortgage situation:
- Faster repayment of the mortgage loan
- Decreased cost of the mortgage over time
- Equity is accrued at a faster rate
- Prepayment reduces principal, making it easier to qualify for refinancing
Essentially, prepayment gives you more control over your loan and gives you an opportunity to save money, build equity and pay off the loan faster. Because you’re paying it down at a quicker rate, you will probably have an easier time refinancing for a better interest rate and loan terms down the road as well.
In addition, because the prepayment is optional, you can always skip prepayments and simply pay the monthly payment because if money is tight. Because of this, a handful of people choose to incorporate prepayment plans into their overall preparations for retirement.
Are There Any Downsides?
While there are definitely benefits to prepaying your mortgage, there are potential downsides at the same time. Some mortgages, especially those with adjustable rates, are designed not to allow prepayments; if you attempt to prepay on the mortgage, this can cause a penalty fee.
Additionally, some lenders only accept prepayments in specific forms and will apply any other money received as simply an early payment against the next month (which means that the money will go toward interest and principal and not just your principal loan balance.)
Attempting to prepay when you have significant debt elsewhere or don’t have a safety net built up for yourself isn’t generally a good idea, either; your mortgage probably has a lower interest rate than most if not all of your other debts, so you may be better off paying them off and establishing savings and retirement funds first before you start worrying about prepaying a mortgage.
Should You Prepay Your Mortgage?
Whether or not you should prepay your mortgage depends upon a number of factors. You should think about the type of mortgage you have, how much your monthly mortgage payments are and what your interest rate looks like.
Furthermore, you should also take a look at your overall finances and how well prepared you are for emergencies and retirement; it’s possible that your money would be better off going elsewhere at the moment.
Even if prepayments seem feasible and affordable, make sure that your lender accepts prepayments without penalty and that you know how they prefer to get prepayments. Those extra payments will not do much good if your lender simply applies them against interest or charges you a penalty fee because prepayments aren’t allowed by your loan.