Learn how an extra payment can reduce your loan term and interest

Why Making One Extra Mortgage Payment a Year Could Change Your Financial Future

Imagine it’s the end of the year and you’re feeling a little extra festive after the holidays. You’ve got a bit of cash left over from your holiday budget, maybe a bonus from work, or a tax refund just hit your bank account. While you could splurge on a new gadget or take a nice vacation, consider this: what if you put that money towards your mortgage instead? It might not sound as exciting, but making just one extra mortgage payment a year can have a huge impact on your financial future.

In this post, we’ll break down how making that extra payment can save you thousands in interest, shorten your loan term and boost your financial freedom. We’ll also share real stories from homeowners who have seen the benefits firsthand. By the end, you’ll have a solid understanding of how this simple move could make a big difference in your life.

The Basics of Mortgage Payments

When you take out a mortgage, you’re essentially borrowing money to buy a home, which you’ll pay back over time with interest. Your monthly payment typically covers three key components: principal, interest and sometimes taxes and insurance.

Understanding Principal and Interest

• Principal is the amount you borrowed.
• Interest is what the lender charges you for borrowing that money.

When you first start making payments, a larger chunk goes toward interest rather than principal. Over time, as your remaining balance decreases, more of your payment will go toward the principal.

How Extra Payments Work

When you make an extra payment, it usually goes directly toward the principal. This means you reduce the amount of money you owe, which can lead to less interest over the life of the loan.

Let’s say you have a $300,000 mortgage at a 4% interest rate over 30 years. Your monthly payment would be about $1,432. If you made one extra payment of $1,432 each year, you could pay off your mortgage about four years early and save over $30,000 in interest.

The Benefits of Making Extra Payments

So, why should you consider this? Here are some solid benefits:

Save on Interest

As we just saw, making extra payments can significantly reduce the interest you pay. The earlier you start making these payments, the more you save in the long run.

Shorten Your Loan Term

Paying off your mortgage early can free up your finances. Imagine not having a mortgage payment in your 50s or 60s. That means more money for retirement, travel, or just enjoying life.

Increased Equity

Every extra payment increases your home equity. This can help if you decide to refinance or take out a home equity loan for things like renovations or investments.

Real-World Scenarios

Let’s look at a couple of real-life examples to see how this works in practice.

Scenario 1: Meet Sarah

Sarah just bought her first home in Denver for $400,000 with a 30-year vs 15-year mortgage at 3.5%. Her monthly payment is about $1,796. Sarah decides to make one additional payment each year.

By doing this, she’ll pay off her mortgage roughly 6 years early and save about $25,000 in interest. For Sarah, that means financial freedom comes sooner than she expected.

Scenario 2: Meet Tom and Lisa

Tom and Lisa purchased their home in Austin for $350,000 with a 4.25% interest rate. They were initially overwhelmed by their monthly payment of about $1,720. After a year, they decided to use their annual tax refund of $3,500 to make an extra mortgage payment.

By committing to this strategy, they’ll pay off their mortgage about 7 years sooner and save around $28,000 in interest. For Tom and Lisa, this means they can focus on saving for their kids’ college funds without the weight of a mortgage hanging over them.

How to Make Extra Payments

Now that you’re sold on the idea of making extra payments, how do you go about it?

Check with Your Lender

Before you start, check with your lender to understand their policies regarding extra payments. Some lenders may apply your extra payment to the next month’s payment instead of the principal.

Choose Your Method

You can make one extra payment a year or split it into smaller payments throughout the year. For instance, instead of one large payment, consider adding a little extra to your monthly payments.

Automate It

If possible, set up an automatic transfer. This way, you won’t be tempted to spend the money elsewhere. You can set it up to transfer right after you get paid, so you can forget about it and let it work for you.

The Impact of Making One Extra Payment

Let’s break down the financial impact of making that extra payment.

A Closer Look at Interest Savings

Using the earlier example, if you make an extra payment of $1,432 each year on a $300,000 mortgage at 4% interest, you’ll reduce your total interest payments significantly. This change can lead to savings of over $30,000, depending on how far along you are in your mortgage.

The Psychological Boost

Beyond the numbers, there’s a psychological aspect too. Knowing that you’re actively reducing your debt can bring peace of mind. It can also motivate you to keep saving and investing in your future.

FAQs About Making Extra Mortgage Payments

1. Can I make extra payments on any mortgage?

Yes, you can make extra payments on most mortgages. However, check with your lender to ensure there aren’t any penalties for doing so.

2. Will my payment be applied to principal or interest?

Typically, extra payments go toward the principal, but it’s always best to confirm with your lender to avoid any surprises.

3. How much can I save by making extra payments?

It varies based on your loan amount, interest rate and how often you pay extra. Use a mortgage calculator to see your specific savings.

4. What if I can’t make an extra payment every year?

That’s okay! Even if you can only make smaller extra payments throughout the year, any additional amount will help reduce your principal and save you money on interest.

5. Is it better to save or make extra mortgage payments?

It depends on your financial goals. If your mortgage interest rate is higher than your savings rate, making extra payments might be better. Otherwise, having a savings cushion is also important.

Next Steps: Take Control of Your Mortgage

Now that you understand the benefits of making one extra mortgage payment a year, it’s time to take action. Start by reviewing your budget to see where you can find that extra cash. Maybe it’s by cutting back on dining out or redirecting a portion of your tax refund.

Talk to your lender about how to apply those extra payments correctly. Don’t hesitate to reach out to a financial advisor if you need help figuring out what’s best for your situation.

Remember, small changes can lead to big results. Embrace the power of that extra mortgage payment and you might find yourself on the path to financial freedom sooner than you think.

For more information on mortgage-related topics, check out these resources: abbreviation for mortgage, are there 50-year mortgages?, blanket mortgage lenders, and California Residential Mortgage Lending Act.