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The Pros and Cons of Prepayment
Paying off a mortgage early is a financial strategy used by many borrowers. Some who prepay their mortgage are motivated by the desire to save thousands of dollars in interest and eliminate long-term debt. Others simply want to own their houses sooner rather than later. Whatever your reasoning may be, it’s critical to understand the pros and cons of prepaying your KC home loan.
Understanding How Your Prepayments Are Applied
Making extra payments on your outstanding debt, or principal loan amount, reduces the interest you will pay over the life of the loan. Interest is reduced because interest charges are figured each month by multiplying the interest rate by the remaining principal.
While most mortgage lenders won’t penalize borrowers for prepaying loans, some will not automatically apply additional payments to the principal balance. If you don’t notify your lender of the intention of your prepayment, the lender may end up putting the extra amount towards paying the interest of the loan or escrows rather than applying it towards the remaining principal.
If you make extra payments of a set amount, you can avoid the above scenario by writing a separate check and attaching a note to it. In the note, tell the lender to use the additional money as extra principal and not to apply it to escrow. Remember to follow up with the lender so you know the extra payments are being applied to outstanding principal.
Prepayment Affects Your Taxes and Interest
It’s true that if you entirely pay off your mortgage, you won’t receive a tax break. On the other hand, prepaying your mortgage helps reduce the amount of interest you pay each month and over the life of the loan. The money you save on reducing your interest will typically outweigh the money you save from your homeowner tax incentive.
It Can Also Affect Future Monthly Payments
Prepaying your home loan can help you build equity in your home more quickly. For some borrowers, the best and simplest way to prepay their KC home loan is to add a specific additional amount to their monthly payment.
Although your interest amount will decrease, individuals who prepay principal will see those extra payments slowly increase over time. Mortgages are set up so that most of the monthly payments go to interest in the early stages with the bulk of principal payments being made towards the end of the term.
Also, keep in mind prepaying your mortgage does not mean you can skip a KC home loan payment. No matter how much a borrower pays in advance, lenders still expect regular, full payments each month and on time.