Aside from credit card bills, auto loans, and personal loans, another type of liability that you may have is a mortgage loan. A mortgage is a loan from a bank, a financial institution, or a third-party vendor that is financially assisting a borrower in purchasing a home. Then comes mortgage prepayments which are done to reduce the outstanding balance.
When you have a mortgage loan, you are essentially locked up in a mortgage note agreement as a security instrument to your lender where you are legally responsible for paying an agreed amount until you reach the maturity date of your loan. The loan is usually sealed in a 15 to the 30-year loan term. Apart from the principal balance that you are required to pay on a monthly basis, you are expected to pay interest as part of your Monthly Contractual Payment (MCP).
That said, some borrowers consider making extra payments towards the principal in order to reduce the outstanding balance and pay off the loan earlier than anticipated. In this section, we will discuss everything you need to know about mortgage prepayment. Let’s begin.
What is mortgage prepayment?
To put it simply, mortgage prepayment entails making extra payments on your loan’s principal balance. The primary reason for doing this is to reduce the outstanding principal balance of your loan, should you have the financial resources. The end result of this is that you will be able to reduce your loan term, meaning that you can pay off your loan in full before you retire or simply free yourself from mortgage debt early on. In doing this, you will also save thousands of dollars on interest and be able to build equity faster.
What are some ways to prepay a mortgage?
There are several ways to prepay your mortgage. Below are some of the ways to do so:
- Lumpsum – Some borrowers decide to pay a huge amount of money if they’ve received a financial windfall, inheritance, salary appraisal, work promotion, or business venture. A lumpsum payment will significantly reduce the principal balance of your loan.
- Annual extra payment – Some borrowers make extra payments towards the principal on a yearly basis. This is also one way to ensure that the outstanding balance is reduced, thus leading to a shorter loan term.
- Extra payment on MCP – Borrowers who have recurring payments or Automatic Clearing House (ACH) payments set-up include extra payments that go directly towards the principal on a monthly basis.
- Combination of all – Some borrowers who have the financial means get to make extra payments towards the principal on a regular basis through a combination of the aforementioned.
What should I consider for Mortgage Prepayments?
You cannot make the decision about mortgage prepayments overnight or whenever you want to. It entails serious thought. While reducing your outstanding principal balance is a great benefit, there are other things to consider. Assessing your financial status is critical to this financial prepayment endeavor. When doing so, you have to consider the following:
- Your monthly budget – if it’s tight or if you have extra.
- Your monthly income – if it’s variable and/or unpredictable.
- The length of time – if you’re planning to stay in your home.
- Your retirement – if you’re saving enough.
- Sufficient emergency savings fund – if you have savings or not.
- High-interest credit cards and other loans
- Your financial goals, income, and budget
These are some of the considerations that you need to be aware of when prepaying your mortgage. There are no hard and fast financial rules when doing so. However, there should be proper discernment and sound decisions made. Being able to reduce your loan’s principal balance is truly fulfilling. No doubt, it frees you of mortgage debt earlier than anticipated.