If you find yourself with a little extra cash at the end of the month, should you put it toward your mortgage loan or refinance to a shorter term? There’s no simple answer. Risks and benefits exist when paying off your loan early or switching loan terms, so the right decision differs for everyone. In this section, we’ll look at a few instances in which it makes sense to pay off your mortgage early – and when it doesn’t. You might assume that you need to shell out hundreds of extra dollars each month to pay off your mortgage early. The truth is, a small monthly amount or a single annual payment can make a major difference over the course of your loan.When Paying Off Your Mortgage Early Works
Contributing just $50 extra a month can help you pay off your mortgage years ahead of schedule. You don’t need to find a way to earn an extra $10,000 a year to pay off your mortgage.
If you’re looking for a tool that can help you understand amortization and estimate what paying off your mortgage early would cost you, try using our Rocket Mortgage® amortization calculator. It’ll help you see for yourself how a small amount can impact your loan. Your result might surprise you. Most people can manage to save at least a few thousand dollars in interest with a small monthly extra payment. This is especially true if you start paying more on your loan in the early years of your mortgage.
The best candidates for early mortgage payoffs are those who already have enough money to cover an emergency. You’ll want at least 3 – 6 months’ worth of household expenses in liquid cash before you focus on paying off your mortgage. This is because it’s much more difficult to take money out of your home than it is to withdraw money from a savings account.
When Making Minimum Monthly Mortgage Payments Works Better
It may not be a good idea to focus on paying off your mortgage early if you have other debt to worry about. Credit card debt, student loan debt and other types of loans often have higher interest rates than most mortgages. This means they accrue interest faster.
By paying these debts down, you’ll save more than you would if you put all your money toward your mortgage. It’s best to review your financial paperwork and compare interest rates of your other debts to your mortgage interest rate. If your other debts have a higher interest rate, you should pay them down first.
Understanding Prepayment Penalties
You also may want to avoid paying your loan off early if it carries a prepayment penalty. This is a fee your lender charges if you make all payments your mortgage prematurely. Prepayment penalties are usually equal to a certain percentage you would have paid in interest.
So, if you pay off your principal very early, you might end up paying the interest you would have paid anyway. Prepayment penalties usually expire a few years into the loan.
Consult your mortgage lender and ask about any prepayment penalties on your loan before you make a large extra payment. Prepayment penalties are also noted in your mortgage contract.
When Balancing Early Mortgage Repayment And Other Financial Responsibilities Works
While it’s possible to take cash out of your home equity with a refinance, this process takes time, which you may not have in an emergency. Make sure you have plenty of money set aside for emergencies before you put any extra toward your mortgage loan.
You may want to delay paying off your mortgage if you have another big expense coming up or you’d rather put money into your 401(k) or IRA. You might also want to consider diverting your extra money into a child’s college fund or into savings for an upcoming vacation or wedding.
There’s no point in paying off your mortgage if it means you might end up going into debt in the future.
