The pinnacle of financial stability is, for many, owning a home free and clear. To reach that pinnacle more quickly, some might put extra money every year toward their mortgages in the form of an extra monthly payment. This scheme does have many advantages, but it's a good idea to review the entirety of your financial situation and consult an adviser as to what's best for you.
How It Works
Consumers have several options. They can establish a bi-weekly mortgage payment plan instead of paying monthly. Since there are 52 weeks in a year, this results in 26 bi-weekly, or the equivalent of 13 monthly, payments a year. They can also increase their monthly payment by the equivalent of an extra monthly payment, divided by 12 months. A regular monthly payment of $1,200 would become $1,300, since an extra monthly payment of $1,200 is the equivalent of an extra $100 every month. Finally, mortgage-payers can send the equivalent of one monthly payment to their bank as a lump sum every year, on top of their regular payments.
Mortgage-Free Sooner
An extra house payment per year will cause the house debt to be paid off more quickly. A $250,000 mortgage held over 20 years at 7 percent interest will have a regular monthly payment of $1,938.25. One additional lump-sum payment of $1,938.25 paid on an annual basis would shorten the life of this mortgage to 17 years, 2 months. That's almost three extra years of a mortgage-free life.
Interest Savings
Paying more towards the mortgage by adding an extra payment every year will result in a reduction of the mortgage debt load more quickly. Since the debt load is reduced, less interest is paid in the long run. The 7 percent, $250,000 mortgage will incur total interest charges of $215,179.36 over the 20-year life of the mortgage, over and above the $250,000 principal. The additional yearly lump-sum payment of $1,938.25 would reduce the total interest paid to $180,118.63, a savings of $35,060.73. The higher the interest rate on the mortgage, the higher the savings through additional payments.
Who Benefits
People who receive biweekly paychecks might find that a biweekly accelerated mortgage works with their household budgeting. Individuals who hold no other debt besides their mortgage, or whose mortgage is the debt they hold that has the highest interest rate, might choose to devote more of their income to getting out of this debt. Those approaching retirement, and who foresee a reduction in their income as they exit the workforce, might want to structure their payments to get out of mortgage debt more quickly. Finally, those looking to refinance might get a better deal if they have less principal to negotiate.
Who Doesn't Benefit
Those who hold higher-interest debt outside of their mortgage, such as credit cards, might save more money by paying off the cards before the house, so devoting the extra payment to this other debt might be a better option. Also, entering into a formalized biweekly pay structure or additional yearly payment can pose a challenge for mortgage payers who find themselves unable to make payments several years into the mortgage and risk default. In this case, a voluntary additional payment, if the bank will accept it without an early-payoff penalty, might be a better option to guard against unforeseen economic problems.
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