Becoming a homeowner is one of the most exciting moments in a person’s life. It’s also one of the biggest financial commitments any of us will ever make. Signing your name on a home loan means committing to a monthly mortgage payment for the next 15 to 30 years, so it’s no surprise many homeowners start looking for ways to shave some time off their loan right away. Typically, that means making extra mortgage payments in addition to your monthly minimum.
But with options to make those extra payments each month or as one lump sum at the end of the year, how do you know your payment strategy is saving you the most money possible? Will one of these methods help you pay your loan off faster than the other? Let’s find out.
Why Make Extra Mortgage Payments?
Mortgage interest — the percentage paid in addition to what you borrow — is not a fixed dollar amount. Instead, it is recalculated at the end of each billing cycle depending on the interest rate you got from your mortgage lender. As the principal of what you owe decreases, the amount of interest you pay also decreases.
That being said, making the minimum payment due on your mortgage each month barely scratches the surface of your principal. Alternatively, when you make extra payments on your mortgage on top of the minimum amount, every cent of that additional payment will go toward the principal. When your interest is recalculated, that lower principal will be reflected in the interest you pay the following month. An extra mortgage payment of $100 toward the principal does not seem like a lot against a $200,000 loan, but if you commit to making that payment regularly over the course of several years, it can add up to months or even years off your mortgage.
In short, the more extra payments you put toward your mortgage, the more money you will save long term. But when it comes to developing a payment plan that works for you and your household, we start to see different schools of thought.
Making Extra Mortgage Payments Monthly vs. Yearly
For the sake of comparison, let’s say two identical families, each with a $150,000 mortgage, both commit to contribute an extra $1,200 per year to their principal. One family decides to pay an extra $100 a month over the course of a year, while the other decides to pay it all in one lump sum at the end of the year. Will one family be better off than the other?
First off, it’s important to note that neither of these is a bad strategy. Both are making a significant investment toward a secure financial future, and, in the long term, each family will be rewarded for their persistence. It’s only on a micro level that we can see the benefits and drawbacks of their respective payment plans.
Talking strictly dollars and cents, the family making smaller monthly payments will save more, but only by a few extra pennies. Now, a few cents add up over time, but the difference will be minimal on a month-to-month basis. It’s only after committing to this strategy over several years that the benefits become noticeable.
If there is a disadvantage to making extra mortgage payments monthly, it’s the inherent risk that comes with shrinking your monthly budget. Once you make a payment to your mortgage lender, there is no getting it back.
On the other hand, the household opting for the lump sum method may pay slightly more in interest, but their strategy also allows them to keep the savings accessible. Life comes at you fast, and if an emergency arises, the family with a lump sum sitting in their bank account could be in a better position to handle unexpected circumstances.
Create Your Own Repayment Strategy
Only you and your family know what you can afford. If you don’t have room in your current finances for any additional mortgage payments, making minimum payments will still get you to the finish line. And, even if you can’t contribute extra funds to your mortgage each month or make a large payment at the end of the year, you can still chip away at your loan by contributing as much, or as little, as you want, whenever you can. Whether you contribute $100 every other month, $200 every six months, or even make biweekly mortgage payments, you’ll still be working to pay off your mortgage faster.
