During the start of a mortgage, it can be extremely discouraging to see more and more of your monthly mortgage payment going towards interest instead of the principle. When a mortgage is at its peak, borrowers are usually unmotivated to pick up speed on repayment. With that being said, people will go to great lengths to shorten the life of their mortgage when the end is in sight. However, is this really ideal? Most mortgages have extreme penalties for extra payments in order to gain the most interest possible.
Without punishment, prepayment privileges grant the ability to arrange a percentage of the principal of your mortgage before the conclusion of the amortization period. Ask lenders what type of pre-payment privileges they allow, since lenders often offer premium rates at the expense of not allowing pre-payments.
For example, a $500,000 mortgage at a 5 year fixed rate of 3.00% interest and amortized over 25 years, would come to a total cost of $709,868.25 over the amortized period. A prepayment amount of $5,000 each year would bring the total cost over the amortized period to $661,228.60, giving $48,639.65 in interest savings.
If a borrower sees the benefit of making extra payments, what is the best way to do it? Most borrowers who have this mind-set plan to make payments periodically when excess income is available instead of scheduling to make consistent, regular payments. The problem with this is that it never works, and borrowers can’t accurately foresee when they will have extra cash or how much will be available. The smart way to go about extra payments is to do them automatically. There are two ways to do this:
1: Set the payment above the minimum required payment right off the bat. Once the above minimum payment is set in stone into your contract, it is extremely difficult to get out of.
2: Like the example I gave earlier, schedule an extra payment to your lender either at the same time as your regular payment or during a separate schedule. This is more appealing than option one because if there are changes in the borrower’s financial health, adjusting the additional payment is a lot easier.
When looking for a mortgage, always look for a contractual agreement that is in the borrower’s best interest, not necessarily the lenders. Lenders profit off the ignorance of borrowers. Borrowers should always know all their options and look for any avenue that has their best interest in mind!