Advantages of overpaying your mortgage

Mortgages are long-term commitments people undertake for the privilege of owning a home.  For most, a mortgage payment means that they will be paying a loan for 20 to 30 years and the bank will own part of their home until the time the mortgage is completely paid.

When a person applies for their mortgage they are often stunned at the amount of interest they will pay over the life of a home mortgage.  For a $100,000 loan at 7% interest, a homeowner will pay slightly more than $139,000 in interest payments on top of the principal of the loan.  In addition, if a homeowner has put less than 20% down on the home purchase, they will also be paying personal mortgage insurance which protects the lender in the event of default.

Benefits of making additional payments

The first benefit of making additional mortgage payments is a homeowner will pay less interest over the life of the loan. For example, if a homeowner has a mortgage of $100,000 at 7% interest rate, their monthly loan payment is $665.30 (principal and interest only).  If the homeowner were to divide this payment into two payments per month, rather than paying 12 payments in a year, they would make 13 payments.  The payments would be $332.65 every 2 weeks. The net result would look like this:

Making 12 payments: 

• Mortgage amount: $100,000
• Start date: January 2011
• End date: December 2040
• Total interest paid over life of loan: $139,508.90

Making 13 payments (e.g., equal payments every two weeks):

• Mortgage amount: $100,000
• Start date: January 2011
• End date: August 2034
• Total interest paid over life of loan $104,913.17

Net result:

• Time saved: 6 years 4 months
• Interest saved: $34,595.73

In addition, homeowners who have put down less than 20 percent will also realize significant savings on personal mortgage insurance as they will reach the 20 percent equity position faster using an accelerated payment schedule.

Warnings about overpaying your mortgage

Some mortgage companies offer a bi-weekly payment option for homeowners.  These plans are often not free and come with not only an up-front enrollment fee but also have monthly fees associated with them.  For most homeowners, paying additional portions of their mortgage on their own will provide more benefits since this option does not carry added fees.  However, homeowners will need to do the following if they elect to overpay their mortgage:

• Include the extra payment with current mortgage payment and note that it is to be applied to the principal portion of the loan;
• Request the lender recalculate the mortgage if you have made additional payments. Some lenders will not do this unless it is requested;
• Review your loan documents.  Loans that contain prepayment penalty clauses may wind up costing you money if you pay down principal early;
• If you made less than a 20 percent down payment make sure you determine when the equity in your home exceeds 20 percent so you may stop paying personal mortgage insurance.  If property values have increased, you may be able to get this waived as well (you will most likely need a property appraisal);
• Contact your tax professional to discuss overpaying your mortgage. There may be tax benefits to not paying your mortgage off faster.  In some instances, homeowners may be better off paying down credit cards or other non-tax deductible interest bearing loans first.

There are many advantages of overpaying your mortgage if you understand  there are also disadvantages.  Understanding your home mortgage loan and the restrictions which may be contained in your mortgage note are the first requirements of undertaking this type of plan.  For many homeowners, the benefits of overpaying their mortgage often outweigh the disadvantages.