One long-term financial planning strategy is to make an extra mortgage payment each year to more quickly pay down the mortgage balance and increase your equity in the house. Over the long term, making that extra payment will save you thousands in interest and significantly shorten the time to pay off the loan. However, If you do not plan to stay in the home, the decision whether to make that extra payment depends on the value of the home in relation to the loan balance.
Extra Payment Effects
An extra -- 13th -- mortgage payment made each year directly reduces the principal balance on the loan by the amount of the payment. Going forward from the date the extra payment is made, you pay less interest and more principal with each additional payment. For example, on a 30-year, $150,000 mortgage at 5.5 percent, the monthly loan payment is $851.68 and the total interest paid over 30 years would be $156,606. Paying an extra $851.68 each year from the outset of your mortgage reduces the amount of interest paid by $29,850 -- easily the price of a moderate new car -- and shortens the mortgage term by five years.
Benefits of Lower Principal
Even if you do not plan to stay in your home until the mortgage is paid off, you can still realize some benefits from a lower principal balance on the loan. Equity in a home can be built by either an increasing market value or a declining loan balance. With your extra mortgage payments, you control some of the loan balance side of the equation. The loan balance decreases at a faster than scheduled pace, increasing your equity value in the home -- assuming a level to rising market value.
Negative Equity Considerations
If your loan balance is larger than the market value of your home, you have negative equity in the home. Making an extra payment decreases the amount of negative equity, but lowering the loan balance may not be of benefit to you if you plan get rid of the house soon. It may be helpful to use a mortgage calculator with amortization to calculate how long it will take to elimated the negative equity with an extra payment each year. Use the information along with how long you plan to stay in the home to see if the extra payment will get you out of the upside down situation before you plan to sell.
Money used to make an extra mortgage payment each year is also extra money you could save or invest instead. Paying extra to reduce a mortgage balance provides the most benefits over a longer, multiyear period. You cannot retrieve extra money paid into a mortgage unless you sell the home or refinance the mortgage. If you plan to leave the home soon, one other option would be to put the money into a savings account to have the money for moving costs.
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