Is There a Downside to Prepaying My Mortgage? | Credit.com (2024)

FAQs

Is prepaying a mortgage a good idea? ›

Pro: You'll cut down on the interest you owe

By increasing your monthly mortgage payments—also called “prepaying” your mortgage—you'll effectively save money in interest charges. Those savings can add up big time. For example, let's say you take out a $200,000 mortgage with a 4% fixed interest rate and a 30-year term.

If you pay off your mortgage early, you'll no longer have any mortgage interest to deduct on your tax return if you itemize your deductions. This change is most likely to affect you if you have a large mortgage, a high interest rate—or both—-and your annual interest payments are substantial.

Prepayment risk is the risk involved with the premature return of principal on a fixed-income security. When debtors return part of the principal early, they do not have to make interest payments on that part of the principal.

Mortgage lenders include the mortgage penalty as a way to market lower interest rates, knowing that they will make up the difference over the life of the loan through interest payments. Or, the lender will receive funds from the prepayment penalty should you pay off the mortgage before they have recouped their costs.

Understanding Prepayment Risk

As such, prepayment risk is the risk that the borrower repays the outstanding principal amount (or a portion of the outstanding principal amount) prematurely and, in turn, causes the lender to receive less in interest payments.

O'Leary's Take on Paying Down Mortgages

To O'Leary, debt is the enemy of any financial plan — even the so-called “good debt” of a mortgage. According to him, your best chance for long-term financial success lies in getting out from under your mortgage by age 45.

The annual limit for these payments is most commonly capped at 15 to 20 percent of the remaining principal balance. The entire amount goes towards your principal, lowering your ongoing interest costs almost immediately.

Do you pay less interest if you pay off a loan early? ›

1. Save money on interest. The faster you can pay off a loan, the less it will cost you in interest. If you can pay off a personal loan early, it can lower your total cost of borrowing, potentially saving you a considerable amount of money.

When you prepay your mortgage, you pay extra toward the loan principal to help pay your loan off sooner and save money on interest. There are many ways to prepay a mortgage, including through biweekly payments, periodic extra payments or a lump sum.

In fact, getting rid of your home loan just one or two years early could potentially save you hundreds or even thousands of dollars. But if you're planning to take that approach, you'll need to consider if there's a prepayment penalty, among other possible issues.

If you pay $200 extra a month towards principal, you can cut your loan term by more than 8 years and reduce the interest paid by more than $44,000. Another way to pay down your mortgage in less time is to make half-monthly payments every 2 weeks, instead of 1 full monthly payment.

To O'Leary, debt is the enemy of any financial plan — even the so-called “good debt” of a mortgage. According to him, your best chance for long-term financial success lies in getting out from under your mortgage by age 45.

If you pay $100 extra each month towards principal, you can cut your loan term by more than 4.5 years and reduce the interest paid by more than $26,500. If you pay $200 extra a month towards principal, you can cut your loan term by more than 8 years and reduce the interest paid by more than $44,000.

Financial advisors recommend prepaying the home loan earlier as the money you prepay goes straight towards reducing the home loan principal and cutting the total interest cost.