Borrowers are able to make prepayments on a mortgage loan by paying extra on their monthly payments towards the principal of the loan. By making larger payments, you are essentially minimizing the balance on the loan and shortening its term.
There are upsides to making prepayments on a mortgage…
- By making payments earlier than required, you are saving on the interest the mortgage is costing you; the sooner you pay off your loan, the sooner you can stop making monthly payments with interest.
- Interest you save on a mortgage is tax-deductible. If you were investing the same money elsewhere, however, you’d be paying taxes on the income you make.
- By paying the principal loan sooner you’re increasing the equity you have on your home, and will be able to own it earlier than expected.
… But then there are the downsides as well.
- Some mortgages come with a “prepayment penalty.” The lenders charge a fee if the loan is paid in full before the term ends.
- Making larger monthly payments means you may have limited funds for other expenses. It also means that you could miss out on investing money in other ventures that could bring you a higher rate of return.
- You may have gotten an extremely low interest rate with your mortgage. In some cases you would save more money making the regular monthly payments for a 30-year term, and using your available funds for other investments.
If you do decide to make prepayments on your mortgage, it is imperative that you point out what you want the extra money to go towards. Make sure that the extra funds go towards principal, not interest. You are not earning any equity on your home by paying interest in advance.