The Pros & Cons of Paying Ahead on Your Mortgage

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If you’re looking for strategic ways to boost your bank account, congratulations: That’s good thinking. Now you need to figure out what plan will work best for you in the long run. Here’s one that might cross your mind: Paying off the principal on your mortgage in advance.

Let’s assume you’ve got a $200,000 mortgage at 3.625 percent across 30 years. Without taking any other factors into consideration, you’ll be paying a total more than $328,000 for that loan during its lifetime. More than $128,000 of that is interest, and it’s a total that rightly intimidates a homebuyer looking to save, maybe to raise a family.

One option is to pay more toward your mortgage principal, shortening the life of your loan and ultimately saving you thousands in interest. One does this by writing a separate check for the desired amount and clarifying to the lender that this is to be paid toward the principal, or base loan amount. If you don’t clarify, this will be accepted as a future interest payment and not save you any money in the long run.

Assuming you have the money in the bank, and are set in terms of a rainy-day fund for emergency purposes, seems like a wise investment, yes?

Not necessarily. There are several questions to ask before opting to embark on a streak of paying off one’s principal. It can be a great savings tool for many, but others might be able to utilize that cash elsewhere.

PRO: You’ll save tons of money in interest over the life of your loan!

CON: You may be missing out on opportunities to get more out of your money.

There’s no denying that paying forward the principal on your mortgage is a great way to save thousands. Take our original anecdote, for example: If you have a $200,000 loan at 3.625 percent for 30 years, you’ll be paying $912 a month for an ultimate total of $328,357.

What if you were to pay an extra $100 a month, addressed specifically for your principal? You’ll end up owning the home nearly five years earlier, and will save more than $23,000 in interest payments. There’s no arguing with those results.

However there may be other options that will save you even more. For example, you can sit on the mortgage for a few years and, after analyzing your situation, perhaps opt to refinance to a 15-year mortgage. This will secure you a lower rate and shorter term. Now, it’s impossible to know what rates will be like five years down the line, so it may be better to just make your regular payments in the short term and then analyze all of your options when you can accurately gauge how much a refinance will save you, compared to paying ahead on your principal.

 

Yes, owning a home is simpler than this. But that doesn't mean it's your BEST investment option.

Yes, owning a home is simpler than this. But that doesn’t mean it’s your BEST investment option.

PRO: It’s the safest investment you’ll ever make!

CON: It’s safe…but there are other safe options that will earn you more.

It’s fair to look at the payments on your home as an “investment.” After all, you stand to come out with a sum that’s much higher or lower depending on your actions. And, in terms of investments, they don’t get much safer than paying your mortgage principal forward.

After all, you’re guaranteed to save the money that your previous calculations foresaw coming from your principal payment plan (assuming you do so responsibly). Stocks can pay off big time…but they’re just as likely to lose money over the course of your ownership. The dealbreaker for the money you save from paying your mortgage payments ahead? It’s not taxable. Earnings made from stocks and bonds are subject to capital gains taxes.

Then again, the current low mortgage rates make investing a more inviting prospect. The amount you gain from even a conservative investment may easily surpass that amount you’ll save in mortgage interest paid.

Another safe option is to put your money in a 401(k) instead, especially one where your employer meets your contributions.

PRO: When you own your home, those monthly mortgage payments will no longer leak from your savings.

CON: It’s tough to access savings that’s locked up in equity.

Part of the joy behind owning a home is knowing that there are no more strings attached. It’s yours. However, many owners also celebrate knowing that they won’t need to make any more mortgage payments. Still waters in your bank account seem to run deep, hence why many rush to end their mortgage payments.

However paying off your home too quickly with all of your cash can leave you in a sticky situation. You technically possess that money, but now it’s in the form of a home. If you don’t want to sell the home, you’ll need to rely on home equity, which is much tougher to access than cash in a savings account, and will require a home equity loan or credit line. Better to keep things simple and keep a healthy rainy day fund on hand with your current mortgage.