Is one additional mortgage payment necessary each year? These three advantages are listed.
An annual supplementary mortgage payment might have a number of significant financial advantages at a comparatively moderate cost. One extra annual mortgage payment not only speeds up the process of paying down your loan, but it also lowers your overall mortgage interest payments and increases your equity faster.
Here are the three main advantages of contributing one more mortgage payment year.
- Reduce the number of years on your loan
If you own a home like almost 90% of Americans do, you most likely have a 30-year mortgage. Compared to a 15-year mortgage, a 30-year loan term offers a more affordable monthly payment; nevertheless, repayment of the debt will take decades.
You can reduce the length of your mortgage repayment period by several years by submitting an additional payment to your mortgage each year, for a total of 13 payments instead of 12.
Your home loan balance, remaining payment term, and interest rate all affect how long you can deduct from your payback term when using this technique. The greater the value of each of these components, the greater the annual additional payment impact. However, even a single additional payment made annually can have a significant impact on the length of time it takes to pay off your mortgage, regardless of your balance, remaining payment term, or interest rate.
Consider a $300,000 mortgage, for instance, that has a 30-year loan term and a fixed interest rate of 7.03%. You make 13 payments of $2,002 per year instead of 12; your monthly payment is $2,002. Your house loan will be paid off in 24 years instead of 30 because that one more annual payment will cut six years off your repayment period.
- Reduce interest costs
Mortgages with fixed rates are amortized. This implies that you make the same monthly payments for the duration of the loan, but as time goes on, the portion of your payment that goes toward interest reduces and the portion that goes toward the mortgage principal increases. Early on in a 30-year mortgage, interest is mostly paid on the principal balance rather than the principal.
However, the amount of your loan that remains based determines your monthly interest rate. This implies that any additional principal payments will accelerate the reduction of the total amount owing on the loan as well as the amount of interest owed.
For example, if a homeowner with a $300,000, 30-year mortgage only makes the required $2,002 monthly payments, they will pay $420,704 in interest over the life of the loan at a fixed interest rate of 7.03%. But making an additional $2,002 a year would not only cut down on six years of payments but also lower the total amount of interest paid to $321,231 throughout the course of the loan, saving the homeowner close to $100,000 in interest over time.
- Quickly increase equity
Building equity in your house is also facilitated by increasing your principle payments. The amount that you owe on your mortgage and the value of your home together make up your home equity.
You can develop equity by paying off your mortgage principal, even though there are situations where changes in your neighborhood’s overall property values are beyond your control. If the value of the home rises or stays the same, as you reduce the amount of your loan, the disparity between what you owe and what it is worth increases.
Adding one more mortgage payment to your annual income allows you to accumulate equity faster. Your loan-to-value ratio will decrease as a result of increasing your principal payment (LTV). Simply confirm with your mortgage lender that the additional payment you are making is going toward principal rather than principal and interest.
Increased equity has the following possible advantages:
getting rid of private mortgage insurance (in the event that your down payment was less than 20%)
enabling you to pay for other expenses or home improvements with home equity loans or home equity lines of credit (HELOCs)
Boosting your earnings once the house is sold
Since it depends on the value of your house, it is impossible to pinpoint exactly how much faster you may develop equity by making one more payment year. However, you can accelerate the process by shortening the time it takes to pay off your debt and by paying less interest.
Options for paying the additional annual mortgage payments
Even if you are unable to make one extra mortgage payment per year, it can still have a significant positive impact.
The homeowner with the $300,000, 30-year mortgage at 7.03%, for instance, would save seven months off the 30-year term and pay over $14,000 less in interest if they made just one extra payment of $2,002 in the first year. The total interest paid would also drop from $420,704 to $406,737.
This implies that even a small increase in your monthly payment might have a significant impact. For instance, adding just $20 a month to the $300,000 mortgage will result in an almost one-year shorter repayment period and an interest savings of nearly $17,000.
Another option is to increase your annual payment by one, but spread it out over a few extra months. For instance, divide $2,002 by 12 and add about $167 to your monthly payment rather than paying the entire $2,002 mortgage in one lump sum each year.
Making biweekly mortgage payments is another simple option to add a few extra dollars each year. For instance, you would spend $24,000 a year if your mortgage payment was $2,000 every month. On the other hand, if you pay $1,000 every two weeks, you will pay $26,000 in total—that is, one extra payment. Compared to merely paying one extra payment a year or increasing the amount each month by one-twelfth, this technique might be simpler on your wallet.
You may calculate how much you can save depending on how much extra you can afford to pay toward your mortgage by using a mortgage payoff calculator.
FAQs for annual additional mortgage payments
If I make one additional payment each year, what would happen to my mortgage?
An additional annual mortgage payment will shorten the repayment period by a number of years, usually between four and six. It will also speed up the process of building home equity by reducing the total amount of interest you pay over time.
Is it preferable to make additional monthly or yearly mortgage payments?
The outcome of either choice will be nearly the same. It is typically easier for homeowners to increase their monthly mortgage payments by 1/12 than to make one extra payment once a year.
Do extra payments to principal get applied automatically?
Your loan principle may not always be increased by additional payments. Extra payments may be applied to future scheduled installments rather than principle by certain mortgage lenders. Tell your lender that you want the extra money allocated exclusively to your principal so that you can be confident the extra payment is going toward the principal on your mortgage.