Making one extra mortgage payment a year can offer several major financial benefits at a relatively low cost. Not only does this extra mortgage payment help pay off your loan early, but it also increases the speed at which you build home equity and reduces the amount of interest you pay over the life of your loan.
Here are three major benefits to making one extra mortgage payment per year.
Learn more: 7 ways to build equity in your home
In this article:
If you’re like nearly 90% of American homeowners, you probably have a 30-year mortgage for your home. A 30-year term gives you a more affordable monthly payment than a 15-year mortgage but requires a decades-long commitment to pay off the loan.
By making an extra payment on your mortgage each year — that’s 13 payments instead of 12 — you can shorten your repayment period by several years.
The exact amount of time you take off your repayment term with this strategy depends on your mortgage loan balance, remaining payment term, and interest rate. The higher each of these factors, the bigger the impact your annual extra payment will have. But even if you have a smaller balance, remaining payment term, or interest rate, making one extra mortgage payment a year can greatly affect the time it takes to pay off your mortgage.
For example, let’s say you have a $300,000 mortgage with a 30-year loan term and a fixed interest rate of 6.75%. Your monthly payment is about $1,946, and you make 13 payments of $1,946 per year rather than 12. That single extra annual payment will shave almost six years off your repayment term, so your home loan will be paid off in roughly 24 years rather than 30.
Learn more: 15-year vs. 30-year mortgage — Which should you choose?
Fixed-rate mortgages are amortized. This means you make the same monthly payments throughout the life of the loan, but the amount of your payment going to interest decreases over time while the amount going to the mortgage principal increases. In the early years of your 30-year mortgage, payments mostly go to interest rather than the principal balance.
But your monthly interest is based on the remaining balance of your loan. This means that any additional payments toward your principal will lower both your outstanding loan balance and the amount of interest owed more quickly.
For instance, say you have a $300,000, 30-year fixed-rate mortgage at a 6.75% interest rate. If you only make the required $1,946 monthly payments toward the principal and interest, you would pay $400,486 in interest over the life of the loan. However, adding an extra $1,946 payment each year would not only shave off nearly six years of payments but also reduce the interest paid to $309,414 over the life of the loan, saving nearly $100,000 in interest payments over the years.
Keep learning: What is mortgage principal, and how do I pay it off?
Making additional mortgage payments also helps you build equity in your home. Home equity refers to the difference between the money you owe on your mortgage versus how much the house is worth.
While changes to your home’s value can sometimes be outside your control — like when overall home values in your neighborhood increase or decrease — you also build equity by paying down your mortgage balance. As you pay down your loan, you increase the difference between what you owe and what the home is worth, provided your home value remains the same or increases.
Making one extra mortgage payment per year helps you build equity faster. Since you are putting more money toward your principal, you are lowering your loan-to-value ratio (LTV). Just double-check with your mortgage lender that your extra payment is going toward the principal, not to the principal and interest.
More equity offers several potential benefits:
-
Eliminating private mortgage insurance (if you made a down payment of less than 20%)
-
Allowing you to take out home equity loans or home equity lines of credit (HELOCs) for home improvements or other expenses
-
Increasing your profits when you sell the home
It’s impossible to calculate exactly how much faster you can build home equity by making one extra payment per year since it depends on your home’s value, but reducing your total payoff time and the amount of interest you pay will speed up the process.
Dig deeper: How much is my house worth? How to determine your home value.
If you can’t afford one extra mortgage payment a year, even one additional payment can still offer big benefits.
For example, if you have a $300,000, 30-year mortgage at a 6.75% rate and make just one extra payment of $1,946 in the first year, it would shave seven months off your 30-year term and reduce your total interest paid from $400,486 to $388,115, resulting in over $12,000 less interest.
Another easy way to make an extra payment each year is to make half-payments on your mortgage every two weeks. For example, if you have a $2,000 monthly mortgage payment, you pay $24,000 annually. If you make a $1,000 biweekly payment, however, you will pay $26,000 total, meaning you have made one extra payment. This strategy may be easier on your budget than increasing each month’s payment by 1/12 or simply making one extra payment annually. Not all lenders offer biweekly payments, but it doesn’t hurt to ask yours about the option.
Learn more: How to pay off your mortgage faster with biweekly payments
Increasing your monthly payment by even a modest amount can make a big difference. For example, adding an extra $20 per month to your monthly mortgage payment on the $300,000 mortgage above will reduce your repayment term by almost a year and save you more than $15,000 in interest.
You can also make one extra annual payment but split it into paying a little more each month. For example, instead of paying the full $1,946 in one lump sum, divide $1,946 by 12 and pay roughly $162 more each month.
Using a mortgage payoff calculator can help you determine how much you can save based on how much extra money you can afford to put toward your mortgage.
Read more: 7 ways to pay off your mortgage faster
If you make two extra mortgage payments per year, you could shave several years off your repayment term and save thousands in interest. For instance, two extra annual payments on a $300,000 30-year fixed-rate mortgage at 6.75% would cut your repayment term by over 9.5 years and save more than $144,000 in interest.
Paying an extra $100 each month on your mortgage principal can add up to big savings. On a $300,000 30-year fixed-rate mortgage at a 6.75% interest rate, your savings would be roughly $65,000 in interest, and you’d shorten your repayment term by more than four years.
Paying extra on your mortgage could be a sound financial strategy if you have a bit of extra cash to spare. Whether you add a bit to your monthly payment or make extra payments throughout the year, you’ll lower your balance faster and likely pay less in interest over the life of your loan.
This article was edited by Laura Grace Tarpley.
