The Lending Coach

Many homeowners strive to pay off their mortgage sooner and reduce the total interest paid over the life of the loan.

One simple yet effective strategy is to make an extra payment each year, essentially turning 12 monthly payments into 13.

This approach accelerates principal reduction, shortens the loan term, and leads to substantial interest savings.

How Extra Payments Work

Mortgage payments are typically structured ( or “amortized”) so that a portion of each payment goes toward interest and the remainder toward the principal. Early in the loan term, a larger percentage of each payment is allocated to interest.

Making an additional payment each year specifically toward the principal helps reduce the overall loan balance more quickly. This creates a compounding effect, as subsequent payments are calculated on the reduced principal, leading to less interest accruing over time.

Advantages

Lower Total Interest Paid – If you overpay your mortgage and direct all of your extra payments towards the principal, not only will the principal amount be reduced, so will the amount of interest you’ll have to pay over the term of the mortgage.

Paying down your mortgage provides the biggest return on investment for those who are planning on staying in their current homes for the long haul.

To illustrate, let’s say you currently have a 30-year fixed-rate mortgage of $300,000 at a 4% rate. By the end of the life of the mortgage, you’ll have paid $215,608.52 towards interest!

Now let’s say you decided to make extra payments of $300 each month. At the end of the mortgage life, you will have contributed $148,215.00 towards interest instead. That’s a savings of $67,393.52!

Keep in mind that this extra money is going strictly towards the principal portion, and not the interest. That means you’ll be able to cut down on your principal portion without having even one single cent of it go towards interest.

Shorten the Time Needed to End Up Mortgage-Free – Using the above example, not only would your interest payments be significantly reduced, you’d also be mortgage-free 8 years and 5 months earlier compared to not overpaying your mortgage.

Build More Equity – Any amount of money that you put towards the principal amount of your loan automatically builds up equity in your home. When you save interest on a mortgage by making extra payments, the equity savings in your home accrue each month.

Extra payments allow you to build equity the moment the extra payment is made. You can then use the equity in your home through a refinance or upon the sale of your property.

Disadvantages

Opponents to overpaying a mortgage argue that the money that would otherwise be stuck in a home loan could be working to make more money over the short- and long-term through investments that yield a higher return.

Missing Out on Other Investments – With interest rates hovering around historical lows over the past few years, many homeowners have been choosing to put their hard-earned money into investments rather than paying their mortgage off early. In fact, may homeowners are choosing to extend the life of their home loans in order to free up additional capital to invest.

This, of course, can only work if the interest rate you’re currently paying on your home is less than the interest you’d be making in your investment vehicle of choice.

To illustrate, let’s use the same numbers as above: say you currently have a 30-year fixed-rate mortgage of $300,000 at a 4% rate. If you had saved that extra $300 per month and used it towards an investment that has historically brought 8% returns, you could potentially end up with $425,000 if the returns remain steady.

In addition to the $108,000 that would have been invested over the 30-year period through regular monthly $300 payments, over $316,000 would be made in interest.

Of course, there’s always the risk that this promised rate of 8% won’t necessarily pan out over the course of the investment. Market conditions can always fluctuate, as we see from time to time.

Lack of Diversification – for the majority people, a home is a major component of their overall assets.

By making additional payments and paying off your mortgage early, you’re not increasing your assets’ worth. While you are becoming debt-free sooner, you’re missing out on the chance to diversify your investments and value of your assets.

How to Do It

There are multiple ways to implement this strategy. One common method is to divide your monthly mortgage payment by 12 and add that amount to each month’s payment. Over 12 months, this totals one extra payment.

Another approach is to save up for a lump sum and make a single extra payment at the end of the year. Whichever method you choose, ensure that the additional amount is explicitly applied to the principal to maximize its impact.

Before adopting this strategy, review your loan agreement and consult your lender. Some mortgages include prepayment penalties, which could offset the financial benefits of extra payments.

Considerations and Precautions

Additionally, ensure that your lender properly applies the extra payment to the principal rather than advancing the next month’s payment. Clear communication and written confirmation can prevent misunderstandings.

In Conclusion

Making extra mortgage payments annually or adding more to each month’s payment are straightforward yet powerful ways to reduce your mortgage principal, shorten the loan term, and save money on interest.

This strategy is achievable for many homeowners with a bit of financial discipline and planning. By committing to this approach, you can take control of your mortgage and work toward financial freedom more quickly.

Is it a good idea for you?  Do reach out to me for more, as I’d be happy to talk with you about how this strategy might help you achieve your long-term financial goals.

The blog postings on this site represent the positions, strategies or opinions of the author and do not necessarily represent the positions, strategies or opinions of Guild Mortgage Company or its affiliates. Each loan is subject to underwriter final approval. All information, loan programs, interest rates, terms and conditions are subject to change without notice. Always consult an accountant or tax advisor for full eligibility requirements on tax deductions.