Paying your mortgage early is a great way to save money. It can reduce the total interest you’ll pay over the life of the loan. Interest is calculated each month based on the principal balance you owe, so paying more on your principal will lead to less interest overall. There are plenty of ways to pay down your principal faster and start reducing the amount of interest you’ll owe. Knowing your options and how they work is the first step to finding what’s best for you.
Here, we explore a few ways to pay your mortgage off earlier. It's a good idea though, to do your research and learn more about the pros and cons, requirements and administrative fees (if any) before moving forward with an option that may work best for your situation.
Refinancing
When you refinance to a shorter term, you replace your current mortgage loan with a new one that has shortened repayment timeline. Let's say you have a 30-year mortgage. You can refinance to a 15-or 10-year mortgage resulting in shortening your payoff time. Shorter term mortgage loans usually allow you to secure a lower interest rate, but this typically results in a higher monthly payment. This is because a larger portion of your payment is going toward paying off the principal in less time. The earlier you refinance in your loan term, the more you tend to save.
Refinancing could be a great option if:
- Your goal is to pay off a mortgage sooner than later
- You're interested in a lower interest rate and long-term savings
- Your interest rate is higher than the current mortgage averages
- If you're financially able to take on a higher mortgage
Recasting
If refinancing your loan isn't the best for your situation, another alternative is to recast. Mortgage recasting involves making a one-time lump sum payment toward your mortgage principal and asking your lender to recalculate your monthly payment — re-amortization — for your existing mortgage loan term.
With recasting, there's an option to potentially lower your monthly mortgage payment (depending on the lump sum payment you make), yet you're not refinancing. This means your interest rate, original mortgage loan term, and maturity date remain the same. However, because your principal amount drops, you will usually pay less in interest over the term of your mortgage loan.
Additionally, recasting may make sense if you have a better interest rate in comparison to the current mortgage averages.
Paying extra on your principal
When you pay extra toward your principal, it brings down the total balance of your loan and reduces your interest over time. If you regularly put extra money toward your mortgage, you can save yourself some payments in the long run. Remember, no matter how you choose to pay extra, you’ll likely need to tell your lender to apply the extra payments to your mortgage principal. Again, any extra payments you can put toward your loan will help reduce the amount of interest you’ll pay. For example, you could:
- Pay one extra payment at the end of the year (in addition to your regular payment)
- Put more toward your mortgage when there's extra money available, like from a bonus at work, a raise, a side-job, a tax refund, or an inheritance.
Act with caution
Always be careful to examine your budget and make certain that not paying off your mortgage early doesn't affect your other priorities like saving for emergencies, paying off any high-interest debt, or even home improvement projects. Again, evaluate your budget and then make a plan that fits your financial goals.
Beware of prepayment penalties. Be sure to check your mortgage loan agreement or check with your lender—some lenders charge a fee for early payoff.
Do thorough research and learn more about the pros and cons, and if there are any requirements and administrative fees for the payoff option that's better suited for your financial goals.