We have all heard about friends or neighbors that have paid off their mortgages early. Many of us wonder how that is even possible in an economy like this. Although not as common as in the past, some people have been fortunate enough to dodge the economic bullet devastating so many others with threats of foreclosure or bankruptcy. However, paying down the mortgage may not be as easy as once thought and there are numerous issues to consider before writing that extra check.
Extra Cash Means Extra Responsibility
Overall, paying off a mortgage early can be very beneficial and save you thousands in interest payments. A family with a 30 year fixed mortgage can pay off their mortgage in 23 years just by paying one extra payment per year or an extra $100 per month to the existing payment. So instead of paying 12 payments a year, making 13 can shed 7 years off the life of the mortgage.
So what is the problem?
The problem is that many people don’t understand how the banks handle these extra payments. Many people are under the impression that paying extra towards their payment goes towards the most recent payments due, when the payments are actually applied towards the back end of the loan. Paying an extra payment is thought to have “banked” an extra payment that is stored away for a rainy day. If finances become tight, people assume they will be ok if the miss a payment or two, since they had been paying extra for months now.
Many people end up in trouble when they assume any extra money that is paid towards their mortgage is available to help during a financial crisis. Once the money is paid to the lender, it is considered theirs. Although your principal loan amount will be reduced, you do not have any stored “credit” for use at a later time.
So how can I have extra mortgage payments saved for use at a later time?
If you are unsure your finances will remain stable over the life of your mortgage loan, it is a good idea to put any extra money into a personal account. Rather than paying the extra money to your lender, put it in a personal savings account and let it accumulate. You may cash it out and apply it towards your mortgage in larger sums every year or 6 months. The idea is that the extra money you have to pay towards your mortgage is still accessible in the event you need it for an emergency. When your finances are stable, apply it towards your mortgage and start saving again for another 6 months to year.