Advantages of Overpaying your Mortgage

There are several advantages to overpaying your mortgage.  Whenever you make an additional payment and apply the funds to the principal balance, you are reducing the total amount of interest you will pay over the life of the loan. As each overpayment is applied to the original amount borrowed, you will also payoff the balance due earlier than the original term.  You are also accelerating the increase of the equity in your home, which has become increasingly important in these times of decreasing home values. 

The mortgage payment on a fixed rate mortgage is determined at the onset of the mortgage based on the principal balance, interest rate and term of the mortgage. If, for example, you take out a $300,000 mortgage at 5.00% for 30 years, you will make 360 payments of $1610.46. If you keep that loan for 30 years, you will have paid $279,769.69 in interest. Keep in mind that with mortgage payments, each month your payment includes some principal reduction, which is very small at the beginning.   If you read the amortization schedule you received when you took out the mortgage, you will see that each scheduled payment has a specific amount that will be applied to interest owed and to the balance of the loan.  The amount of interest you pay each month is calculated on the principal balance at the beginning of the month.  Whenever additional funds are paid on the principal balance, the amortization is reset. 

Based on the example above, if you round up your payments to $1700.00 each month, with the additional $89.54 being applied to the principal balance, your loan will be paid of in 319 payments (26.58 years). The total interest savings would be over $36,000.              

Mortgage pre-payment can also be done as a lump-sum payment.  Many homeowners vow to pay a portion of their annual bonus or income tax return towards the principal balance of their mortgage. For those that stick to this resolution, this is a great way to decrease the total cost of their loan and pay it off early. Paying $2500 once a year would reduce the term of the loan by a little more than 5 years, saving more than $39,000 in total interest paid.

A few words of caution before you start making extra payments to your mortgage.   Contact your lender to see if your mortgage has a pre-payment penalty.  If so, discuss the terms with the lender to see when you can start making additional payments.  Also, keep in mind that overpaying your mortgage will not reduce your obligation to make your monthly payment in the event you should lose your job.  A good rule is to invest in a savings plan before you start on a mortgage reduction plan.