When it comes to paying down debt, it is usually better done earlier than later. Naturally, people have floated the idea of paying an extra mortgage payment once annually. This has become a hot topic in the real estate world. Anything that might result in your home being paid off sooner sounds good, but how significant is the benefit of paying an extra mortgage payment once per year? There are many different points of view on this topic, and we will help you navigate them. By getting down to the facts, and alternative strategies, it is time to figure out if this is a good idea.
As is pretty commonly stated, paying an extra mortgage payment helps you reduce the length of your loan term. This means that you will build equity in your home faster, and own it outright sooner. Getting the debt monkey off of your back earlier can mean reduced stress, and less time worrying about making payments. The key to these extra payments is to make sure they are “apply to principal” or “principal-only” payments. That is how you make the most out of these extra payments, as it will affect your interest paid by the end of the term.
That leads us into our next benefit: lowering your interest. Interest on a mortgage, like most other loans, is based on the principal you owe. while the rate you pay is usually fixed (if you picked a good loan), the interest still varies based on the amount you have left in principal. Paying down this principal early means that your interest is calculated on a lower value each year, reducing how much you will pay pretty significantly by the end of the loan term.
The first negative of paying extra principal payments, specifically one per year, is that it doesn’t affect your payoff time very much. One extra mortgage payment each year will usually only cut your term by 1 or 2 years. This is a nice-to-have, but isn’t all that substantial. This can lead to a bit of a letdown when you realize what you may have passed up to get this done. Alternative uses of this money actually have the potential to grow your wealth even more. These include, but aren’t limited to:
- Making sure you are contributing your maximum employer match to your retirement account
- Paying off higher-interest debt
- Reinvesting that money into the stocks/bonds on your own
- Using the money to further your money-making potential through education
All of these alternatives contribute to the most significant drawback: better alternative options. If you aren’t contributing your max employer match, you are literally losing out on a free 100% return on your money. Paying off mortgage debt can save a lot of interest, but not when you have much higher interest being applied to other outstanding debts; pay those off first. If you’re still early on in your savings journey, investing in some educational courses or licensing programs can easily net you thousands more in income each your, if not tens-of-thousands. All of these have the potential to far outweigh the benefit of paying a single extra mortgage payment each year.
What Should You Do?
Check the list of possible alternatives, and see which apply to you. Do you already contribute the maximum employer match each year? Are you already free of auto loan or credit card debt? Do you already have a pretty sizable portfolio in the stock market? Have you already gotten all the education or licensing you need or want? These are all things to consider, and if you check the boxes, then maybe you should pay the extra payment. Provided you don’t have larger ambitions for the money, it wouldn’t hurt to pay off your loan faster. Just make sure you don’t have bigger and better ideas first.
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