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4 Mistakes to Avoid When Paying Off Your Mortgage Early

Paying off your mortgage ahead of schedule could be a good idea if you want to save money on interest. In the process of getting rid of your home loan just one or two years early, you could potentially save hundreds (or even thousands) of dollars. But if you’re planning to take that approach, it’s important to avoid the pitfalls that some homeowners run into.

Basics of Paying Your Mortgage Early

Plenty of homeowners would love to fast forward to when they can own their houses outright and not have to worry about monthly mortgage payments any longer. It’s understandable for many reasons. You can lessen the amount of interest you pay over the term of your loan, and you can gain the stability of having full ownership of your house sooner.

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 doesn’t 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, you’ll pay off the entirety of the loan earlier than the scheduled time.

Finally, you can also refinance your loan to a shorter term. So if you have a 30-year mortgage term, you could potentially refinance to a 15-year or a 10-year. Loans with shorter terms tend to have lower interest rates attached, so this can help you save on interest as well as reach full ownership sooner.

If you’re considering paying off your mortgage ahead of time, make sure you avoid these mistakes.

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, let’s look at an example.

Let’s say you’re considering making a one-time payment of $20,000 toward your mortgage principal. Your original loan amount was $200,000, you’re 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 same $20,000 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.

Everyone’s financial situation is unique, and it’s very possible that the notion of being out of debt is so important to you that it’s 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.

2. Not Putting Extra Payments Toward the Principal

Throwing in an extra $500 or $1,000 every month won’t necessarily help you pay off your mortgage more quickly. Unless you specify that the additional money you’re 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 you’re 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.

3. Not Asking If There’s a Prepayment Penalty

4 Mistakes to Avoid When Paying Off Your Mortgage Early

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, you’re essentially costing the lender money. That’s why some lenders try to make up for lost profits by charging a prepayment penalty.

Prepayment penalties can be equal to a percentage of a mortgage loan amount or the equivalent of a certain number of monthly interest payments. If you’re 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.

4. Leaving Yourself Cash-Poor

Throwing every extra penny you’ve got at your mortgage is an aggressive way to get out of debt. It could also backfire. If you don’t have anything set aside for emergencies, for example, you could end up in a tight spot if you get sick and can’t 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 don’t 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.

5. Extending Your Loan Term When Refinancing

4 Mistakes to Avoid When Paying Off Your Mortgage Early

Refinancing can save you money on interest. But in some cases, it could cost you more in the long run, especially if you’re planning to extend your loan term. Before you refinance, it’s a good idea to crunch some numbers and figure out whether having a longer mortgage term makes sense.

And don’t forget to think about closing costs. If your lender agrees to let you roll those costs into your loan, you could end up paying more money. After all, you’ll be paying interest on a larger loan amount.

Final Word

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. If it’s something on your radar, make sure to seriously consider all of your options so you can be sure it’s actually the best path forward for you.

Tips for Buying a House

  • Securing a mortgage can be a stressful and confusing processes. You need to figure out what term is best for you, whether you want a fixed or variable rate and where you can actually get the best mortgage rates. Our home buying guide can help simplify the process.
  • To guide you through this big financial decision, you might want to talk to a financial advisor. SmartAsset’s financial advisor matching tool can help you find a person to work with to meet your needs. Just tell us where you’re located and answer some questions about your financial goals, and we’ll find up to three advisors right in your area.

Photo credit: ©iStock.com/ArtMarie, ©iStock.com/PeopleImages, ©iStock.com/DeanDrobot

Rebecca Lake Rebecca Lake is a retirement, investing and estate planning expert who has been writing about personal finance for a decade. Her expertise in the finance niche also extends to home buying, credit cards, banking and small business. She's worked directly with several major financial and insurance brands, including Citibank, Discover and AIG and her writing has appeared online at U.S. News and World Report, CreditCards.com and Investopedia. Rebecca is a graduate of the University of South Carolina and she also attended Charleston Southern University as a graduate student. Originally from central Virginia, she now lives on the North Carolina coast along with her two children.
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