Making extra mortgage payments can pay off, but should you?
It’s a strategy that crosses the mind of many borrowers when they take on a home loan: Make an extra mortgage payment or two every year and save tens of thousands of dollars in interest.
The move can shave off costs for a home loan and ensure it’s paid off faster. Even one additional payment a year can translate into big savings.
On a $250,000, 30-year mortgage with a fixed rate of 4 percent, making an extra payment every year would save the homeowner roughly $27,724 over the life of the loan. It would also cut the amount of time needed to pay back the loan by 4 years and one month.
Even so, there are potential financial drawbacks to consider. Borrowers who can afford to make extra mortgage payments tie up cash that could be put toward retirement or used for emergencies.
“It’s really important to look at your financial health in the broader sense,” said Suzanne Martindale, staff attorney at Consumer Union. “The most important thing is to maintain in good standing all of your debts.”
Here are some tips to consider before taking steps to make extra payments on your home loan:
1. WEIGH YOUR PRIORITIES
It may be tempting to double down on your mortgage payments, but doing so before you’ve taken care to shore up your finances overall isn’t a good idea.
Financial advisors recommend ensuring that you are saving for retirement and have set aside three to six months salary to cover emergencies. If you have children, you’ll also want to put saving for their college tuition ahead of making extra mortgage payments.
“At today’s low mortgage rates, if you are cutting into your retirement savings to pay off a mortgage, you are likely making a mistake,” said David Mullins, an independent financial advisor in Richlands, Virginia. “You don’t want to have your nest egg tied up in a property where you can’t easily convert it to cash.”
2. SLASH OTHER DEBT FIRST
Paying off high-interest debt such as credit cards is another priority that should be put before focusing on paying down your home loan faster. Consider also paying off car loans, too.
That’s because home loans are likely the least costly debt a borrower will have, especially if they took advantage of low mortgage interest rates. In addition, homeowners are allowed to take a deduction on their income taxes for the interest paid on their home loan.
3. DO IT YOURSELF
You’ve decided to accelerate payments on your mortgage, so what is the best approach?
There are many ways to get there, including paying a little bit extra every month, or making a lump-sum payment at the end of the year. Another approach involves paying half of your mortgage every two weeks. Over the course of a year, you end up making 26 payments, which works out to an extra monthly payment.
Contact your lender to make sure they allow extra payments and will apply the additional funds toward the principal on your loan, not interest.
Try the extra payments calculator from Bankrate.com to compare how much money the different approaches to making extra mortgage payments will save you.
4. WATCH OUT FOR FEES
The various fees that lenders charge on top of the interest rate may offer you some room to negotiate a better deal, especially if you have comparable rate quotes from other lenders. Once you negotiate a reduction in those fees, they are locked in along with the interest rate, which means you’ll know exactly how much your loan will cost you.
Regardless of the payment plan, steer clear of companies that offer to handle your extra payments for a fee, said Martindale.
“Consumers need to be very wary from sales pitches from third-party companies,” she said. “If they’re charging a fee for their service, it can undercut any potential benefits they might be offering.”
The Consumer Financial Protection Bureau has sued several companies that offer to handle borrowers’ twice-monthly mortgage payments. The agency claims the companies misled consumers about how much they could save in interest on their home loan.
One company, Paymap, agreed last year to pay a $5 million civil penalty and return $33.4 million in fees to consumers. Another firm in the biweekly mortgage payment collection business, LoanCare, agreed to pay a $100,000 civil penalty.
The CFPB has a similar lawsuit pending against another company, Nationwide Biweekly Administration.