Your Mortgage: The pros and cons of an extra mortgage payment

By Charity Ohlund

Have you heard of the cool way to make an extra mortgage payment every year? No, not the one where you make a full extra payment at the end of the year. That’s not a secret and coming up with an additional full mortgage payment, especially in December, is not that cool.

By default, mortgage payments are made once per month, equating to 12 full mortgage payments in a year.

But what would happen if you were to make biweekly payments? Under this strategy, either you or your lender would split your monthly payment in half and submit a payment every two weeks. This is where a quirk in our calendar allows you to get ahead.

There aren’t a uniform number of days in each month, and so by making biweekly mortgage payments, you’ll make 26 “half-payments,” or 13 “full” payments per year instead of the normal 12 payments. In other words, you make one extra full payment per year, and you won’t even feel it because you’ve budgeted for it.

It’s important to distinguish here that we are talking about equal payments every two weeks – not two equal payments per month. That would equal 24 half payments, or 12 full payments. That’s fine if you just want to avoid a large withdrawal around the first of the month. But it’s the 26 half payments that really begin to offer some additional benefits. Such as …

  • Paying less interest over time
    When you make a mortgage payment, the bank actually splits up up the money and divvies it out to various things. During the first few years after you take out your mortgage, most of the money will be going toward interest and very little will be going to reducing the balance of your loan (sadly). This process is called amortization, and anyone who’s ever had a loan literally had to pay their dues, especially during those first few years.But here’s where making biweekly mortgage payments can really help you. Since you’ll be making an extra payment each year, you’ll pay down the principal even faster. This means that each interest payment thereafter will be smaller than if you hadn’t made that extra payment. Over the course of your loan, this can save you a significant amount of money.
  • Building equity faster
    Continuing that thought, one of the biggest benefits of making biweekly mortgage payments is that you build home equity faster. When you make biweekly payments and manage to squeeze in that extra payment each year, you’ll be making extra payments toward reducing the balance of your loan. And that extra payment will give you a small push toward building equity.There are a lot of advantages to having as much home equity as possible. For example, if you have enough home equity, you can take out a home equity loan to finance things like home repairs or remodels, or you can increase your proceed when and if you sell your home.
  • Dropping your PMI sooner
    In 2017, the average homebuyer bought their home with a 10% down payment. That’s not bad, but for most conventional loans (not including FHA, VA and USDA loans), you’ll need a down payment of at least 20% to avoid paying for private mortgage insurance each month. Once you reach 20% equity in your home, you can ask your conventional lender to cancel your PMI payments. If you make biweekly payments, you can actually get there a lot faster because you’ll be paying down the balance of your loan quicker than normal.
  • Paying off your mortgage sooner
    By now, you get the idea so I won’t belabor the point. But when you make an extra payment, you’ll pay off your loan quicker. Let’s look at a quick example. This scenario assumes a $200,000 loan with a 30-year fixed term at 4.125% APR.

                                                       Monthly Payment        Biweekly Payment
Payment Amount                               $775.44                     $387.72
Number of Payments Per Year        12                                 26
Total Paid Per Year                        $9,305.28                   $10,080.72
Number of Years to Pay Off          30                                  25 years 10 months
Total Interest Paid                        $119,158.25                  $100,077.57
Total Cost                                          $325,158.25                  $306,077.57

Conversely, there are also a  few benefits to NOT making an extra payment. These include:

  • Paying off credit card debt
    If you’re having a hard time with credit card debt like many Americans, it’s more than likely you don’t have enough available cash to commit to paying extra on your mortgage. Your credit card rates are going to be significantly higher than your home loan interest rate, so it makes sense to tackle credit card debt first. Credit cards typically carry the highest cost to borrow with an average variable interest rate of about 16%.
  • Refinancing to a lower rate
    This may sound strange to skip paying extra principal and refinance your mortgage instead, but it could prove to save you more and still let you keep the extra money you’d pay toward your principal for other alternatives. The idea is that you may be able to lower your current rate without resetting your term. Your breakeven point could also end up being sooner than you think. Talk with our team at Fountain Mortgage to see if this might make sense for your situation.
  • Building up a rainy-day fund
    Save for an emergency. We recommend setting aside 3 to 6 months’ worth of living expenses in savings just in case you lose your job or incur unexpected costs. Without those financial reserves in place, you could put your mortgage in jeopardy, which includes the extra money you worked so hard to put toward it if you’re making extra mortgage payments
  • Investing in the market
    You could make more money by using additional principal payments to invest in the market … depending on how long you plan to stay in the home.

Consider how long you plan to stay in your home. If you won’t realize the benefit of making extra payments before you plan to sell the home, investing what you would have paid extra might better choice.

When mortgage rates are low (like they are now), it’s assumed to be at least a couple of percentage points lower than what a moderate risk investment portfolio is likely to earn.

This weekly Sponsored Column is written by the employees of Fountain Mortgage. Located in Prairie Village, Fountain Mortgage is dedicated to educating, and thus empowering, clients to make the best financial decision possible for their situation. Contact Fountain today.

Mike Miles NMLS ID: 265927; Fountain Mortgage NMLS: 1138268