When you prepay your mortgage you pay off your loan amount before the due date. This can be accomplished by putting a little extra money into your monthly mortgage payment each month or making an additional payment or two each year. Refinancing is also considered a prepayment as the current loan is paid off and you take out a new loan, typically with a lower interest rate. Over the life of your loan, that extra payment or refinance savings can potentially reduce the amount of interest you will pay by thousands of dollars. However, before you decide to prepay, it’s important to understand what it could mean to your wallet.
Let’s take one example. You have a $200,000 loan on a 30-year mortgage. At 4 percent interest, you are paying $954.83 a month (not including taxes and insurance). If you increase the payment to $1,100 or an extra $145.17 a month, you will save $35,812.62 in interest over the life of the loan and knock down your term to 23 years and 4 months.
Bi-weekly mortgage payments can also add an extra payment to your loan if it's offered by your lender. It’s important to do the math and see if you can afford to do the extra payment consistently to get the most bang for your buck.
One thing to consider is if there is a prepayment penalty. Not all lenders have a penalty for prepayment, but for those that do, the penalty can be incurred if you pay off the mortgage in full in the first few months or years. That penalty can be around 2-4% of the loan. If there is a prepayment penalty, then you would have been advised of it in your closing documents.
Before you decide to prepay or refinance, check your closing paperwork to see if there is any pre-penalty document. It would say something like pre-payment disclosure. Once you find it, check to see how much the penalty is and the term. Some penalties may only be for the first few years. If you’re close to reaching that threshold, then it may be better to wait.
It may also make sense to do the math before you make a decision. Even if there’s a prepayment penalty, the savings on the interest may be worth it or to reduce the terms in a refinance or pay-off. Consider how long you want to stay in your home. The longer you stay in your home, the more benefits you may get from prepaying or refinancing your mortgage.