Is it your dream to own your home free and clear? You are not alone. Is it possible, though? You borrowed a lot of money for a term of 30 years. How could just an extra $100 here or there make a difference? In the grand scheme of things, it really could make a difference. However, there are reasons you shouldn’t pay more towards your mortgage. Here we look at the good and the bad so you know if you should pay more towards the principal or not.
A Little Difference at First
Don’t get discouraged if you pay an extra $100 a month and during the first year you see very little change in the interest you pay. It takes a long time to get to the point where you start saving interest. However, when you get to that point, the difference is huge. Your payment at the onset of a mortgage is mostly interest. You likely only pay a small amount towards the principal. Adding an extra $100 doesn’t make a huge difference right away. Your interest charges are still pretty hefty as they are based on the amount of the outstanding principal.
If you stay consistent, though, your extra payments add up. Let’s say you only pay $100 more each month. Over the course of one year, you pay an extra $1,200. For many people, this may equal one full mortgage payment. After five years of consistent payments, you pay $6,000. The amount accumulates as time goes on, obviously. The more principal you pay, the less interest you owe. This helps you own your home faster. Now granted, $100 per month is not going to knock too much time off your loan, but every little bit helps. Over the course of the loan, you stand to save thousands of dollars in interest, so never give up.
Reasons not to Pay Extra Towards the Principal
It seems like a great idea to pay extra towards the principal. Who wouldn’t want to save thousands of dollars on interest. However, there are certain situations where it doesn’t pay to make those payments.
- Are you in credit card debt? The interest charged on your credit cards probably far surpasses the interest you pay on your mortgage. You don’t do yourself any favors by paying the mortgage rather than the credit cards. If you have an extra $100 or more per month, put it towards the credit cards. This way you pay them off and stop paying the 15% or higher interest rates. You don’t receive any tax benefits from paying credit card interest, but you may receive some benefits from mortgage interest.
- Do you have money saved? If you don’t have an emergency fund, every extra dollar you have should go into that account. You cannot predict the future. You don’t know what will happen. No matter how secure you think your income is, having a backup plan is necessary. Focus on saving at least 6 months’ worth of your expenses in order to survive during that time and figure out the next step. This account should take priority over owning your home free and clear.
- Are you set for retirement? Okay, nobody is really set for retirement, but are you saving for it? Whether you contribute to a 401K or IRA, you will need the money some day. If you have not set yourself up yet or you don’t regularly contribute, it is best to focus on these accounts first.
- House equity isn’t liquid. Think about this long and hard. You cannot just take the cash out of your home equity. You have to go through the process of refinancing. There is no guarantee you will be able to refinance depending on your financial situation. Even if you can refinance, you have to wait several weeks or even months for approval. If you need the money now, this really doesn’t do you any good.
Reasons to Pay Extra Towards the Principal
There are some obvious benefits of paying your mortgage off early. Here are a few:
- You pay less interest. This is the most basic reason. It may not even be about owning your home earlier. Just the fact that you may save money in the long run is worth it. You won’t ever see the interest money again – there is no return on your investment. If you stand to save a few thousand dollars and are in a financial position to do so – go for it!
- Own your home faster. Owning a home has many benefits. You can enjoy the financial freedom of no more mortgage payments. There is something to be said about that. If debt weighs you down and keeps you up at night, get it paid off.
- Enjoy retirement. No one wants to pay a mortgage payment while they are retired. Retirement is supposed to be a time that you enjoy life. While you are still young and capable, put as much money as you can towards the home to get it paid off. Don’t ignore the above tips regarding debt and savings, though.
How to Make Extra Payments
There are many ways you can make extra payments towards the principal of your loan. Here are a few of the most common:
- Pay an extra set amount each month – As in our example of an extra $100 per month. You can pay whatever amount you are comfortable paying.
- Make bi-weekly payments – Instead of making one large monthly payment, pay half of the mortgage payment every two weeks. This results in one extra mortgage payment each year without any effort.
- Apply windfalls – Bonuses, tax returns, and inheritances are all great monies to put towards the principal of your loan. This unexpected money shouldn’t have a use in your daily expenses, so why not pay down the principal of your loan?
Whether you should pay extra towards the principal of your loan is a personal decision. Take a close look at your financial life. Are you in debt? Do you have savings? These answers would help you decide whether you should pay more principal each month or not. Keep in mind, you can start paying your principal down whenever you are capable of doing so. No one is holding you accountable and it does not affect your credit whether you do or don’t pay extra towards your mortgage loan.