Unless you are concerned about prepayment penalties, you can pay as much as you like, whenever you like, against the principal balance of your mortgage. Even if there is a penalty, you can pay up to just under the amount specified without incurring penalties and then accelerate your prepayment as soon as the penalty period expires. Prepayment can be done as a lump sum or as a modest amount added to your monthly payment. A one-time payment of a few thousand dollars can accelerate your loan nicely, but the disciplined approach of making an additional monthly principal payment can cut the life of your loan drastically, build equity and save thousands in interest.
Review your mortgage agreement to learn your annual percentage rate, contractual payoff date and prepayment terms, including any penalties. Adding penalties for early repayment is your lender's way of making sure he gets his profit on the money he lent if you pay the loan off early. It is usually assessed only on prepayments made within a set number of years at the beginning of the loan.
Review your mortgage statement to see your remaining principal balance. This is whatever you borrowed, less whatever you have paid back to date. If you just got your loan, this will be the amount you borrowed. Let's say you are at the beginning of a 30-year loan for $250,000, with a 4 percent annual percentage rate, or APR, and a period of two years in which a prepayment penalty of 4 percent will be levied on any additional principal payment in excess of $10,000. Our contractual monthly payment is $1,193. 54.
Decide how much time you want to shave off your loan and subtract that number of years from your contractual payoff date. Let's cut 10 years from our hypothetical loan and make it a 20-year loan.
Go to an online loan calculator, such as the one at Bankrate.com, and plug in the principal you still owe, your interest rate and the years left from the present to the date you have chosen to pay it off. Press "calculate" and the calculator will give you the monthly payment needed to achieve that payoff date. In our example, the revised monthly payment would be $1,514.95.
Subtract your contractual payment from the acceleration payment to learn how much extra you will pay each month toward principal. In our example: $1,514.95 minus $1,193.54 equals $321.41 extra each month.
Multiply the monthly principal payment by the number of months left on the period of time in which you would be charged a prepayment penalty. This gives you the total extra principal you would pay in that period. Our example calls for a two-year penalty period, so $321.41 multiplied by 24 equals $7,713.84 above our contractual payments.
Compare the principal total for the penalty period to the maximum amount you are allowed to pay during that period. In our example, the ceiling is $10,000 -- $2,286 more than what our accelerated payment would be -- so we would incur no penalty. If your prepayments are more than what is allowed, then cut down the amount of the monthly principal payment, so that you will have paid just under that minimum until the penalty period has expired. As an added treat to yourself, save up the remainder of the extra you would have paid each month and use it to make a lump sum payment the day after the prepayment period ends.
Billie Jo Jannen is a politics and lifestyle columnist in rural San Diego County and a senior copy editor for Demand Media. Her writing and editing career spans 23 years, and she specializes in border and environmental affairs. Jannen's eclectic education includes engineering and horticulture, and she represents the Rural Economic Action League in regional economic development planning.