Paying off your mortgage can seem like a process with no end in sight. With a 30-year mortgage term, you have to make 360 total monthly payments. But if you have recently received some extra money or got a raise at work, you can pay off your mortgage much earlier using an early mortgage payoff.
What is an early mortgage payoff?
An early mortgage payoff allows you to end your mortgage term much earlier by adding to each monthly mortgage payment. This extra amount is dedicated to paying off the principal amount of your mortgage. While your current mortgage payment is both an interest payment and a principal payment, early mortgage payments are used only as a principal payment. By paying more each month, you are effectively shortening your mortgage term because your mortgage term ends when you repay the full principal amount.
Pros and cons of an early mortgage payoff:
Pro: Each month, the interest charge is calculated as a percentage of your remaining principal amount. As you pay off your mortgage, the interest charge goes down because each month, you pay off a bit more of the principal amount. With an early mortgage payoff, you are paying off the principal amount faster, so your interest charge will go down. You can end up saving thousands of dollars in interest depending on how much you add to your monthly payment.
Con: The U.S. tax code lets you use any interest payments on your mortgage as a federal tax deduction for up to $750,000. If your interest expense decreases, you may end up paying more tax and the benefit of using your money to pay off your mortgage early may be close to zero.
Pro: By putting more money into your home, you are essentially buying equity in your home. If you decide to sell your home, you will receive all of that money back when you need it. This can be an alternative to your 401(k) and a great incentive for saving more money.
Con: Since you are putting money in your home, you won’t be able to use it for other purposes. Unfortunately, homes are very illiquid by nature, which means if you need the cash, it may not be available immediately. However, there are some home equity tools available like a HELOC or home equity loan to access a portion of that equity.
Pro: In some cases, lenders will charge prepayment penalties if you try to make large lump-sum payments early on in your mortgage term. If this is the case, then you can avoid any penalties with an early mortgage payoff. Virtually all mortgage lenders will allow adding an extra amount to your monthly payments. There is probably a clause in your mortgage contract that outlines how much you are allowed to add and you can ask for more.
Con: Adding an extra amount each month means your interest savings will increase gradually. If you recently received a large sum of money, you could save more on interest by using it all immediately on your mortgage instead of adding a small portion of it each month.
How do you add early mortgage payments?
While everything described above has been based on you adding some amount to your monthly mortgage payment, there are a few different options for early mortgage payoffs.
As mentioned, you can ask your mortgage lender to let you add some set amount to your monthly payment as long as you specify that the extra payment should be used to repay your principal balance.
You could also add a “13th” annual mortgage payment. Instead of making 1 payment each month, you could add one extra payment at the end of each year and dedicate this payment towards repaying your principal. By doing this, you can just add however much you want.
The last common option is bi-weekly mortgage payments. At the end of every other week, simply pay half of your monthly payment. Since most months are slightly more than 4 weeks, at the end of the year, you will end up making about a full extra payment. You can ask your lender about this option or refinance your mortgage with a third-party service. Alternatively, you can add 1/12th of a monthly payment to each of your monthly payments to replicate the same results.
So, is it worth it?
Whether or not you should pay off your mortgage early depends on your financial situation. Now, you understand the mechanics of it and exactly what it brings to the table. If you have no better use for your money and have some savings left over for a rainy day, then you should consider it. However, you are under no obligation to and it is just one of the many uses of your money. If you are unsure about what your mortgage contract allows you to do, talk to your mortgage lender.