Put More Money Back Into Your Pocket
What few people know is that a prepayment strategy on your mortgage can be the best way to save money and get a guaranteed return on your home. This is why having the right prepayment privileges as part of your mortgage contract is essential. Let us explain.
Early payments can be made in a variety of ways: paying a lump sum, making an extra payment each month, or making an extra payment every payment.
Prepayment on a mortgage has two attractive effects: you’ll pay less money overall in interest and you’ll pay down the entire mortgage faster.
Additionally, prepaying a mortgage can be comparable to making an investment with a guaranteed financial return.
Due to the high-interest rates and stock market volatility, you could be more likely to generate a better return by paying down your mortgage. For example, if your current investments or cash in savings are generating you a lower return than the interest rate you are paying on your mortgage, it’s likely that paying down your mortgage will outperform both.
How does it work:
Let’s say you have an outstanding mortgage balance of $500,000 at an interest rate of 5% and your mortgage is being amortized over 25 years. Your monthly payment is $2908.
If you were to renew your mortgage every 5 years at 5% interest and simply make your regular payments over the next 25 years, you will pay an extra $372,409 in interest. So your $500,000 mortgage is now really $872,409, nearly double.
That’s a lot of lost money and investment opportunities each year.
Now let’s look at what would happen if you used your prepayment privileges to pay down your mortgage early.
Let’s say you decide to increase your mortgage payment by $500 per month at the time you take out the initial mortgage. All else being equal, the total interest you would have paid is now $269,269 and you would have paid it off in the 18th year. You will have essentially saved $103,140 in interest over the life of that mortgage by making $108,000 in early payments directly to the principal.
Let’s look at using a lump sum each year. Let’s say you get an annual bonus and decide to make a lump sum payment of $5,000 each year. You’d be done paying your mortgage off on the 20th year, and would essentially have made $90,000 worth of early payments to your mortgage principal, saving you $81,208 in interest over the life of that mortgage.
Instead of paying all that extra interest, you are now seeing a guaranteed return back in your pocket from your home.
Summary: when interest rates are low, leveraging the low rates and investing in other areas is often more beneficial. In higher-rate environments like today, paying down mortgage debt could be a guaranteed way to save you more money in the long run.