Should I Pay Extra on my Monthly Mortgage Payments?

Making additional mortgage payments on my Bay Area mortgage…..good idea?

With people taking out such large mortgages here in the Bay Area, there is always talk or the question of the whether its a good idea to pay extra on the mortgage to reduce the balance faster.  Making that decision even more difficult is the fact that rates are sub-4%.  

In theory, paying extra on your mortgage makes good financial sense.  It means a near-guaranteed return on your investment, which isn’t always the case for other investments or places you park available dollars.  As a thought, if you have a mortgage at 4.5%, you are essentially guaranteed to earn 4.5% – by saving in interest – on any amount of principal balance that you pay off early.  Most all loan allow for you to make additional payments on your loan, as prepayment penalties are nearly a thing of the past now. However, making extra mortgage payments isn’t always the right strategy for every homeowner.  Some borrowers opt for refinancing to shorter term loans, like the popular (but seldom sought) 15 year mortgage, which severely cuts the amount of interest they WOULD have paid.  

So what exactly happens when you send in extra payments?  When making a regular payment, there is interest AND principal comprising of that total.  If you are to write a separate check that is included with your payment, specifically noted/marked as “ADDITIONAL PRINCIPAL,” the lender will apply this payment as a full reduction to the loan balance.  Over time, this can save tremendous amounts of interest, especially during the initial years of the loan when most of the payment is only being applied to interest for the lender.  

I mentioned earlier that this strategy isn’t for everyone.  You should always consider the fact that a mortgage is the cheapest money you will ever borrow, especially these days, and if you have other debt obligations, then they should probably assume priority for any extra payments.  Other high interest debt such as credit cards, personal loans, auto loans, and even student loans should all be handled first before paying down a mortgage.  A reminder – your mortgage interest is tax deductible and other interest loaded debt is not.  So by prepaying principal, you will pay less interest and in the end, get less of a write off over the life of your loan.
Priority with extra funds for a household should be:
1) Credit cards
2) Rainy day fund (12 months of income in case of a job loss or economic downturn)
3) 401K contributions for the year/employer matches
4) House or other retirement accounts.  

To look closer into whether refinancing or paying down your mortgage makes sense in todays rate environment, shoot me an email at arjun@lendclear.com to learn more or apply now to weigh out your options.