Early Mortgage Payoff
What is the wisdom advanced by paying your mortgage principal early? There are many reasons why people pay off a mortgage early. They may want to be debt-free, for example. They may want the house paid off before retirement.
From a strictly financial point of view, it is smart to pay down or pay off the mortgage if you expect the after-tax returns on your investments to be less than the effective rate on your mortgage. The effective rate includes any realized tax benefits from the mortgage interest deduction. A mortgage with a stated rate of 4.5 percent might have an effective rate in the mid threes depending on your tax bracket and your ability to fully utilize the deduction.
Your interest payments are based on your outstanding loan balance, not on your monthly principal payment. If you pay next month’s principal payment, you will save a little interest, but not that much because your overall balance hasn’t been reduced by that much.
If the mortgage interest rate is 4.5 percent, a month’s worth of interest on a $100 prepayment of principal is 37.5 cents – not exactly a gold mine, is it? However, if you keep making additional principal payments every month, you can significantly reduce your interest payments over time. For example, if you pay an additional $100 to your principal every month, it will reduce the interest and loan term significantly.
The mortgage magic in prepaying your mortgage is not in reducing intramonth interest expense. It comes from paying down your outstanding loan balance with additional principal payments. By making additional payments on the borrower’s mortgage, it is possible to both dramatically reduce the amount of interest paid and also pay the mortgage off quicker – giving the home buyer a bigger margin for safety each month and allowing them to live mortgage-free sooner. The amount saved will vary based on the initial size of the loan and interest rate.
When considering the option of paying mortgages off more quickly, it is not uncommon to hear the term of “mortgage cycling” come up. Quite often consumers will see books and ads promising a solution for paying of your mortgage more quickly while saving more money. When considering “mortgage cycling”, various establishments who offer their services may be quite helpful if the borrower is less than familiar with the idea that by paying extra towards your monthly mortgage payment, the loan will be paid off in less time and a great deal of money can be saved in interest.
Source: Why Pay Extra toward Mortgage Principal?” Why Pay Extra Toward Mortgage Principal? Web. 03 Mar. 2013. “Saving By Paying Extra on Mortgage.” Paying More on Mortgage. Web. 03 Mar. 2013.
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