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What to Know Before Prepaying Your Mortgage

Posted by  on Feb 14, 2012
 

Mortgage rates are rock-bottom these days, and a lot of homeowners are refinancing their home loans to lower their payments. If you're in the enviable position of having extra cash each month, you may be wondering if you should skip the refinance and put extra income toward prepaying your mortgage principal.

Before you do, know that prepayment is not for everyone. Here are steps to take before simply escalating your loan payments.

1. Review your finances

If you have a lot of credit card debt and other bills you are struggling to pay on time each month, then it is premature to worry about prepaying a mortgage. The money that would go toward extra payments would be more useful if it went toward high-interest credit cards, auto loans and other debt. You should also make sure you have a savings account established with a decent-sized emergency fund before prepaying a home loan.

2. Determine what you can pay

If you determine that you want to go ahead with prepayments, get as much information about your mortgage as possible. You should know the interest rate and the breakdown of how much of your current payments goes toward principal vs. interest. (A standard amortization calculator can help with this. You can also consult HSH.com's mortgage calculator, which allows you to input one-time or monthly prepayment of principal to see its effect on your loan balance.)

Since the payments are optional, it is up to you to decide how much to put toward prepaying your mortgage. However, the more consistent you are with making extra payment on your loans, the quicker you'll pay down the balance. If you get a windfall of money such as a bonus, you can also use that to pay down your mortgage debt in a single lump sum.

3. Assess your prepayment options

Some banks allow you to set up a payment plan where you pay half your monthly mortgage payment every two weeks. This works out to making one extra payment a year. Setting up automatic biweekly payments may be a good idea if you don't want to have to think about it every month. Find out whether your mortgage lender charges a fee for setting up biweekly payments.

You could also choose to add an extra amount to your monthly mortgage payment. It is important to use the payment slip that comes with your bill or write a note to designate how much of your payment should go to pay down the principal.

As you pay down the balance of your mortgage loan, the amount of interest you pay over the life of the loan also falls. If you have a fixed-rate mortgage loan, the amount of your monthly payments will not change. What does change, however, is how much of your payment gets applied to principal. As the loan balance falls, less of the payment will go toward interest.

4. Consider refinancing your mortgage

Prepayment could work for you, but if your goal is to lower your interest rate and monthly payments, consider refinancing your mortgage. Current mortgage rates are as low as they've ever been, so take time to shop around and compare loan offerings.

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