It’s no rocket science that if you can afford to pay off your mortgage debt ahead of schedule, you will probably save some money along the way on your loan’s interest if nothing else. As a matter of fact, in many instances, getting rid of your home loan just one or two years prior to the deadline could conceivably save you thousands of hard-earned dollars.
Nevertheless, if you plan on taking this approach and paying off your mortgage earlier, there are certain things you would need to consider before proceeding with your plan. For instance, you’ll have to take into account if there is a prepayment penalty, among other imaginable issues.
To make things easier for you, below you can find the top four mistakes you should definitely avoid when paying for your mortgage early.
Not Checking If There’s A Prepayment Penalty
Mortgage lenders are in the business of making money, and charging you interest on your loan is their primary way of generating income. So, when you decide to prepay your owed mortgage, you’re basically costing them money, which is why many lenders make up for these lost profits by charging a prepayment penalty.
Prepayment penalties or yield maintenance fees are usually equal to a percentage of the mortgage loan payment or the equivalent of a particular number of monthly installments. If your contract comes with a yield maintenance fee for prepayment, that means that if you’re paying off your house well in advance, those fees can add up promptly. For instance, a 4% yield maintenance fee on a $300,000 mortgage would cost you $12,000.
Or, in other words, in the process of trying to save some money by paying off your mortgage prematurely, you could actually end up losing money if you have to pay a sizeable penalty to do so.
Not Putting Additional Payments Toward The Loan Principal
Putting in an extra $600 or $1,200 each month won’t necessarily help you pay off your debt more quickly. And unless you designate that the extra money you’re putting on the table is meant to be applied to your loan principal’s balance, the lender may instead use this money to pay down interest on your next payments.
So, if you’re writing separate checks to make extra principal payments, make sure that you note that in the memo line of the document. Or, if you pay your mortgage online, check if the lender will let you include a note designating how your extra payments should be used.
Leaving Yourself Cash-Poor
Putting each extra dollar you’ve got on your mortgage is a fierce, pushy way to get yourself out of debt. Nevertheless, leaving yourself cash-poor can also backfire, because if you don’t have anything left for emergencies, you may have to be forced to use your credit line to cover unexpected bills or take an additional loan.
Moreover, if you don’t have an already set up emergency fund, your best option might be to put some of your additional mortgage payments in a brand new “rainy day” fund. Once you have six to nine months’ worth of expenses saved, only then should you focus on paying down your mortgage debt early.
Stretching Your Loan Term When Refinancing
Refinancing loans can save you money in different ways, as it permits you to convert to either a longer or shorter loan term, depending on your wants and needs. So, if you’re ten years into a 40-year mortgage term, you could prospectively refinance to a 20-year term and shave off ten years. On the other hand, you can also go for another 40-year term and potentially lower your monthly installments.
Nevertheless, loans with shorter terms usually have lower interest rates, permitting you to both reach full ownership much sooner and save on interest. However, in many cases, refinancing could cost you more in the long run, particularly if you’re planning to extend your term. For that reason, before you refinance, it’s a good idea to sit down with an accountant, crunch some numbers, and figure out if having a longer mortgage loan term really makes sense in your case.
Last but not least, keep in mind the closing costs as well. If your mortgage lender accepts to let you roll those costs into your loan, you could also end up paying more than what you first imagined.
In the end, the decision of whether you should pay off your mortgage debt early depends on how much money you have to spare and other important factors that are unique to your situation. Whatever you decide, make sure to carefully consider all of your options and make an informed decision that will bring no financial harm to you.