The motivation for prepaying a mortgage is simple -- you save money on interest. And, it can
add up to a lot of money.
If you want an example, visit our mortgage
prepayment calculator.
There are two basic ways of prepaying a mortgage:
- You can create a prepayment schedule yourself. Each month send a separate, second
check to your lender, indicating that the money is for prepaying the principal. Watch out
for, and inquire about, prepayment penalties for paying down principal in the early years of
the loan. Don't start prepaying without contacting your mortgage servicer first to find out
exactly how the payment should be handled.
Example: Let's say you have a 30-year fixed mortgage of $100,000. The interest rate
is 7 percent. The monthly principal and interest payments would be about $665, and you would
pay $139,508 in interest over the life of the loan. By adding $25 a month, you could shorten
the term by more than three years and save $18,214 in interest. For an extra $100 a month,
you would save $50,506 in interest and shorten the term by nearly 10 years.
- The mortgage servicer can set up a formal biweekly prepayment plan, but there will
be an initial fee, usually a few hundred dollars, plus a processing fee for each payment.
You pay half the monthly mortgage amount every two weeks. At the end of the year, the extra
money is sent to the lender to pay down the principal.
Example: On a 30-year fixed mortgage of $100,000, instead of 12 monthly payments of
$665, or $7,980 a year, you would make 26 biweekly payments of $332.50, or $8,654 annually.
The total interest would be reduced $34,130 and the loan term would be shortened to about 24
years.
Tips
Be sure to consider the tax implications of prepayment. Prepaying reduces mortgage interest,
which is tax deductible. That may not be beneficial in your tax bracket. It also might be
more profitable to put that extra cash in an investment account.