What happens when you pay off your mortgage early

If you can afford to pay off your mortgage ahead of schedule, youll save some money on your loans interest. In fact, getting rid of your home loan just one or two years early could

What happens when you pay off your mortgage early

If you can afford to pay off your mortgage ahead of schedule, youll save some money on your loans interest. In fact, getting rid of your home loan just one or two years early could potentially save you hundreds or even thousands of dollars. But if youre planning to take that approach, youll need to consider if theres a prepayment penalty, among other possible issues.Below are five mistakes that you should avoid when paying your mortgage off early.A financial advisor can help you figure out your mortgage needs and goals.

What Does It Mean to Pay Off Your Mortgage Early?

Many homeowners would love to fast forward to when they own their houses outright and no longer have to worry about monthly mortgage payments. As a result, the idea of paying off their mortgage early could be worth exploring for some people. This will allow you to lessen the amount of interest youll pay over the term of your loan, all while giving you the ability to become the homes full owner earlier than expected.

There are a few different methods by which you can go about paying early. The simplest method is just to make extra payments outside of your normal monthly payments. Provided this route doesnt result in extra fees from your lender, you can send 13 checks each year instead of 12 (or the online equivalent of this). You can also increase your monthly payment. By paying more each month, youll pay off the entirety of the loan earlier than the scheduled time.

If youre considering paying off your mortgage ahead of time, make sure you avoid these five critical mistakes.

Mistake #1: Not Considering All of Your Options

It can be very tempting if you come into some extra money to put that toward paying your mortgage off ahead of time. However, getting out of debt a little bit earlier may not be the most remunerative choice to make. To illustrate this, lets look at an example.

Lets say youre considering making a one-time payment of $20,000 toward your mortgage principal. Your original loan amount was $200,000, youre 20 years into a 30-year term, and your interest rate is 4%. Paying down $20,000 of the principal in one go could save you roughly $8,300 in interest and allow you to pay it off completely 2.5 years sooner.

That sounds great, but consider an alternative. If you invested that money in an index fund that represents the S&P 500, which averages a rate of return on 9.8%, you could earn $30,900 in interest over those same 10 years. Even a more conservative projection of your rate of return, say 4%, would net you $12,500 in interest.

Everyones financial situation is unique, and its very possible that the notion of being out of debt is so important to you that its worth a less than optimal use of your money. The important thing is to consider all of your options before concluding that paying off your mortgage earlier is the best path for you.

Mistake #2: Not Putting Extra Payments Towards the Loan Principal

Throwing in an extra $500 or $1,000 every month wont necessarily help you pay off your mortgage more quickly. Unless you specify that the additional money youre paying is meant to be applied to your principal balance, the lender may use it to pay down interest for the next scheduled payment.

If youre writing separate checks for extra principal payments, you can make a note of that on the memo line. If you pay your mortgage bill online, you might want to find out whether the lender will let you include a note specifying how additional payments should be used.

Mistake #3: Not Asking If Theres a Prepayment Penalty

Mortgage lenders are in business to make money and one of the ways they do that is by charging you interest on your loan. When you prepay your mortgage, youre essentially costing the lender money. Thats why some lenders try to make up for lost profits by charging a prepayment penalty.

Prepayment penalties can beequal to apercentage of a mortgage loan amount or the equivalent of a certain number of monthly interest payments.If youre paying off your home loan well in advance, those fees can add up quickly. For example, a 3%prepayment penalty on a $250,000 mortgage would cost you $7,500.

In the process of trying to save money by paying off your mortgage early, you could actually lose money if you have to pay a hefty penalty.

Mistake #4: Leaving Yourself Cash-Poor

Throwing every extra penny youve got at your mortgage is an aggressive way to get out of debt. It could also backfire. If you dont have anything set aside for emergencies, for example, you could end up in a tight spot if you get sick and cant work for a few months. In that case, you may have to use your credit card to cover your bills or try to take out an additional loan.

If you dont have an emergency fund, your best bet may be to put some of your extra mortgage payments in a rainy day fund. Once you have three to six months worth of expenses saved, you may be able to focus on paying down your mortgage debt.

Mistake #5: Extending Your Loan Term When Refinancing

Refinancing can save you money in multiple ways, as it allows you to convert to either a shorter or longer loan term, depending on whats best for you.So if youre 10 years into a 30-year mortgage term, you could potentially refinance to a 10-year term and shave off 10 years. On the flip side, you could go for another 30-year term to lower your monthly payments.

However, loans with shorter terms tend to have lower interest rates, allowing you to both save on interest and reach full ownership much sooner. In some cases, though, refinancing could cost you more in the long run, especially if youre planning to extend your loan term. Before you refinance, its a good idea to crunch some numbers and figure out whether having a longer mortgage term really makes sense.

Dont forget closing costseither. If your lender agrees to let you roll those costs into your loan, you could end up paying more money. After all, youll now be on the hook for interest on a larger loan amount.

Bottom Line

Whether you should pay off your mortgage early ultimately depends on how much money you have to spare, what your alternatives are and other factors that are unique to you. But if its something thats legitimately on your radar, make sure to seriously consider all of your options.

Although often known for their expertise in investing and financial planning, many financial advisors are knowledgeable about mortgages and home purchases. So if youre struggling to make a decision on your own, consider consulting with a local financial advisor.

Tips for Buying a Home

  • A financial advisor can guide you through major financial decisions, like the purchase of a home.SmartAssets free toolmatches you with up to three financial advisorswho serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If youre ready to find an advisor who can help you achieve your financial goals,get started now.
  • Securing a mortgage can be a stressful and confusing process. For starters, you need to figure out what term is best for you, whether you want a fixed or variable interest rateand where to get the best mortgage rates.

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