2/26/2019
Types of mortgage loans
Which mortgage is right for you? Learn about the different types of home loans and how to choose a mortgage that will fit your needs.
Ashley Eneriz
Should you pay off your mortgage early?
The answer depends on your financial goals
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Your mortgage is likely your biggest debt, and you probably feel it each month when your mortgage payment is due. While the thought of being without a mortgage payment is exciting, there are a few things to consider before you start taking on side jobs or throwing extra funds at your home loan.
Yes, paying off your mortgage early will save you thousands of dollars on interest, but it can hinder other financial goals. Read on to find out if it’s the best move for you.
Key insights
- Most lenders will not charge a prepayment penalty for paying off your mortgage early.
- You can pay off your loan early through small regular monthly payments or one lump-sum payment.
- Even adding $50 to your monthly principal balance can save you thousands in interest.
Can you pay off your mortgage early?
If you have the financial means to pay off your mortgage early, you certainly can. Just confirm with your mortgage lender for any specific guidelines or penalties for early mortgage payoff.
When making extra payments toward your mortgage, check that these additional funds are applied to the principal balance. Some lenders may apply extra payments to the interest or hold them as "prepaid" amounts rather than immediately reducing the principal — which won’t help you reach your payoff goal as quickly.
To maximize the benefit of early payoff, verify with your lender how it handles extra payments and if there are any specific instructions you need to follow.
What is a prepayment penalty?
Prepayment penalties are fees imposed by the lender for paying off your mortgage earlier than scheduled. Most conventional loans today have no prepayment penalties, but you will want to check your mortgage lender’s terms from the closing documents to be sure.
Prepayment penalties are illegal under federal law for some types of mortgages, including FHA loans, USDA loans and VA loans. You may have to follow other lender guidelines for prepayment, which could include providing written notice in advance of the prepayment.
How to pay off a mortgage early
There are a few ways to pay off your mortgage early — from adding an additional $50 to your monthly mortgage payment to paying a one-time lump sum.
Here’s a breakdown of the different strategies you can use to save money and shorten your loan term.
- Lump-sum payment
- You can make a large one-time payment toward the principal balance of your mortgage. This could come from savings, an inheritance, a bonus or any other significant source of funds.
- Accelerated payment
- Instead of making monthly payments, you can increase the frequency of payments. For instance, you could switch from monthly to biweekly payments, making 26 half payments in a year instead of 12 full payments. This can result in extra payments being applied annually, helping to pay off your mortgage faster.
- Extra principal payment
- You can add additional funds — say, an extra $50 — to your monthly mortgage payment. You’ll need to clarify that these funds should go toward the principal; otherwise, the lender might apply it toward the following month’s payment. Most lenders let you assign the extra payments to the principal online.
Even a small amount tacked on to your required payment can save you thousands of dollars in interest over the life of the loan. On a $250,000 mortgage at 3.25% for 30 years, an extra monthly payment of $50 can cut at least two years off the mortgage and save you $11,405.09 in interest.
- Refinance to a shorter term
- Refinancing is a common early repayment tactic. This essentially means you take out a new loan to pay off the current loan, then start your mortgage over based on the remaining loan balance and the equity you’ve established.
For example, refinancing to a 15-year mortgage from a 30-year term would likely increase your monthly payment, but it would also cut the amount of time you pay interest. Plus, you’d save yourself up to 15 years of house payments.
Pros and cons of paying off your mortgage early
“Paying off a mortgage early is similar to a double-edged sword. On one hand, it can provide a sense of financial freedom and security, much like a bird breaking free from a cage. You eliminate a monthly payment, save on interest and increase your home equity,” said James Allen, the founder of the personal finance website Billpin.
“However, on the flip side, it can also tie up your cash in an illiquid investment, similar to locking your money in a vault to which only time has the key. You might lose the opportunity to invest in other avenues that could potentially offer higher returns.”
Pros
- Eliminate a monthly payment. Paying off your mortgage sooner will eliminate that obligation from your monthly budget.
- Save money in interest. You’ll save money in interest over the life of the loan, even if you only pay off the mortgage a few years early.
- Increase equity. Paying off principal also increases your equity in the home, which can help when you decide to sell or need to do a cash-out refinance.
- Reduce PMI payments. Private mortgage insurance (PMI) is required on a conventional mortgage unless you’ve put down 20% or built 20% equity in the home. Reaching 20% sooner will eliminate that cost sooner.
Cons
- Forgo other investments. The money you use to pay off the mortgage could be invested in stocks, bonds, mutual funds or other investments for higher returns.
- Cash tied up in illiquid investment. Houses are considered illiquid investments, which means they can’t be converted to cash easily if you need funds for an emergency.
- Lose the mortgage interest deduction. The interest you pay on your mortgage is tax deductible, which means it helps reduce the amount of income taxes you pay each year.
- Prepayment penalty (if applicable). Some mortgages have a prepayment penalty, charging a percentage of the balance if you pay off the loan in full early.
» MORE: Pros and cons of paying off your mortgage before retirement
FAQ
When does it make sense to pay off your mortgage early?
It may make sense to pay off your mortgage early if you’re near retirement. Many individuals make less money in retirement than in their working years, so you may need the additional funds to cover your regular living expenses. It may also make sense if you have a great deal of extra income each month, even after paying off debts and funding savings and retirement accounts.
When is it a risk to pay off your house early?
It doesn’t make sense to allocate additional funds to your mortgage if you have other debt with a higher interest rate. In most cases, mortgages have some of the lowest interest rates available and credit cards have some of the highest.
Early mortgage repayment also doesn’t make sense if you can invest the funds to make a higher profit than the interest you’re being charged on the loan. It doesn’t always make sense to pay off your mortgage early if you have an expensive prepayment penalty that costs more than what you’d save in interest.
Will paying off my mortgage early affect my credit score?
Paying off your mortgage early should not directly impact your credit score as long as you have been making regular, on-time payments. In fact, an early mortgage payoff might even improve your credit score over time by reducing your overall debt.
Bottom line
Before choosing to pay off your mortgage early, you’ll want to consider your financial situation. Think about your short- and long-term goals and the overall liquidity of your investments — how much cash could you get access to if you need it in a pinch?
Whether you put extra funds into investment or retirement accounts or prioritize owning your home free and clear is ultimately your call. If you’re having difficulty deciding what to do, speak with a financial advisor about your options and how each scenario benefits you in the long run.
- Article sources
- ConsumerAffairs writers primarily rely on government data, industry experts and original research from other reputable publications to inform their work. Specific sources for this article include:
Consumer Financial Protection Bureau, “What is a prepayment penalty?” Accessed Aug. 7, 2023.
- Securities and Exchange Commission, “Saving and Investing: A Roadmap To Your Financial Security Through Saving and Investing.” Accessed Aug. 7, 2023.
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