What Happens If You Make 2 Extra Mortgage Payments a Year?

Did you know that making extra mortgage payments can significantly reduce the amount of interest you owe and shorten the life of your loan? By paying down your loan principal faster, you can save money on interest, pay off your home faster, and take control of your future finances.

Making just two extra mortgage payments a year can profoundly impact your financial situation. It can help you build equity in your home, reduce your debt burden, and create a more stable financial future. This article will explore the benefits of making extra mortgage payments and show how this simple strategy can help you achieve your financial goals. 

What Happens When You Make Extra Mortgage Payments?

Making extra monthly mortgage payments directly impacts your principal loan balance and the total interest paid over the life of the loan because you’re paying down the loan amount ahead of the amortization schedule. To understand how this works, let’s first explore the concept of mortgage amortization.

Mortgage amortization is the process by which your monthly mortgage payment is applied to both the principal and interest of your loan. In the early years of your mortgage, a larger portion of your payment goes towards interest, while a smaller portion goes towards the principal.

As you continue making payments, this ratio gradually shifts, with more of your payment going toward the principal and less toward interest.

The Impact of Extra Payments

When you make an extra mortgage payment, you’re directly reducing the principal balance of your loan. Instead of your extra payment being comprised of both an interest and principal portion, the entirety of the extra payment goes toward lowering the principal balance.

Because interest can only be charged on the existing principal, lowering that amount effectively decreases the interest you pay as immediately as the following month.

While your monthly mortgage payments will remain the same amount, a lower principal balance means that a larger portion of your regular monthly payments will go toward paying down your principal. Therefore, while you may only make one or two extra monthly payments, your loan principal will decrease exponentially with each regular mortgage payment.

As a result, by incorporating extra mortgage payments and paying off the principal faster, you can shorten the length of your loan, increase your home equity, and own your home sooner.

The more frequently you make extra payments, the faster you’ll reduce your mortgage debt. If you want to maximize your loan payments, consider making bi-weekly payments or paying extra toward your monthly principal. Even small, regular payments can add up over time and significantly impact your loan.

How Much Can You Save with Two Extra Mortgage Payments?

Making two extra mortgage payments in a year might not seem like a huge dent in your mortgage, but it can significantly impact the life of your loan. But just how much can you save? And is it worth the reduced cash?

Let’s look at an example of a $300,000 30-year mortgage with a 6% interest rate. The monthly mortgage payment on this loan is $1,799. By making two extra mortgage payments of $3,597 per year, the homeowner, in this example, can save about $115,000 in interest costs.

While two extra mortgage payments in a lump sum payment might not be feasible for every owner, even small additional payments can add up over time. For example, paying just $100 more per month on top of your regular mortgage payment can significantly impact your principal balance and shorten the life of the loan. This small extra mortgage payment can save you approximately $53,000 in interest payments and allow you to pay off your mortgage three years early.

Comparison: Extra Payments Annually, Bi-Annually, or Monthly

While it can be confusing, the timing of your extra payments can significantly impact how much interest you pay over time and how quickly you pay off the loan. Extra payments are most effective the earlier you make them in the life of the loan.

That means that if you can make an entire extra month payment this month, it’s better than stretching those payments out over the course of a year. However, most homeowners don’t just come into enough cash to immediately pay for an entire extra mortgage payment.

If you need to “save up” to make an extra mortgage payment, it’s actually more beneficial to make small extra monthly payments each month instead of saving up for an entire payment. Making small additional payments each month can have the greatest impact on your loan term and interest savings as each small additional monthly payment will lower your loan amount, meaning you won’t be charged interest on that portion.

However, if you receive a large lump sum of cash from a bonus or inheritance that you want to put toward your mortgage, it is best to make an immediate extra payment and not spread it out over several months.

How Many Years Do 2 Extra Mortgage Payments Take Off?

If you’re asking yourself, “What happens if I pay 2 extra mortgage payments a year,” then you should not just consider the savings on interest but also how much faster you will pay off the loan.

Assuming a $300,000 mortgage with a 6% interest rate, making two extra payments per year can pay off a mortgage 29% faster or nine years earlier. This is because the extra payments are applied directly to the principal, reducing the outstanding loan balance and the amount of interest paid over time.

Using an online mortgage calculator, it’s easy to calculate and see how the loan term decreases and how the interest savings add up: Without making any extra payments, the total interest paid over the life of the loan would amount to about $347,514.57 over 30 years. However, by incorporating two extra payments, homeowners can save $115,514.70 and only pay $231,999.87 in interest over just over 21 years.

By incorporating two extra mortgage payments a year, the homeowner in our example reduces their total mortgage costs (with interest) from $647,514.57 to $531,999.87

Benefits of Making 2 Extra Mortgage Payments a Year

Making two extra mortgage payments a year can have a considerable impact on your long-term financial standing. Here are some of the benefits you can expect.

Shortened Loan Term

Two extra mortgage payments a year can pay off your loan early and save thousands of dollars in interest. For example, if you have a $300,000 30-year fixed-rate mortgage at 6% interest, making two extra payments a year can help you pay off your loan in about 21 years instead of 30. For homeowners preparing for retirement or who want to limit their debt obligations, making extra payments is a great way to reduce their loan term.

Interest Savings

One of the best benefits of making two extra mortgage payments a year is the reduction in total interest paid over the loan period. By paying off your loan early, you’ll save thousands of dollars in interest that would have been paid over the life of the loan. Based on our previous example, making two extra payments a year can save you about $115,000 in interest over the life of a 30-year mortgage at 6% interest.

Improved Financial Flexibility

Becoming mortgage-free sooner provides financial freedom and flexibility. When you’re no longer tied to a mortgage, you’ll have more resources available for investments, savings, or other financial goals. You’ll also have the peace of mind that comes with knowing that you own your home outright. This can be especially beneficial for people nearing retirement or wanting to pursue other financial goals, such as investing in a second home or starting a business.

Drawbacks of Making Extra Mortgage Payments

While making extra mortgage payments can be a great way to pay off your loan faster and save money on interest, there are some potential drawbacks to consider.

Prepayment Penalties

One potential drawback is prepayment penalties. Some lenders may charge a penalty for paying off your loan early, which can negate some of the benefits of making extra payments.

Check with your lender before making extra payments to see if there are any prepayment penalties associated with your loan. If there is a prepayment penalty, weigh the cost of that penalty against the interest savings.

Inflation and the Cost of Money

Another considerable consideration is inflation and the cost of money. When inflation is higher than your mortgage interest rate, it may not be smart to pay your mortgage off faster. This is because the value of money today is more than the value of money in a month or two (or in two years).

For example, let’s say you have a mortgage with a 6% interest rate, and inflation is currently at 8%, like what happened in 2022. In this scenario, the value of money is decreasing over time, which means that the money you have today is worth more than the same amount of money in the future. By paying off your mortgage faster, you’re essentially using more valuable money today to pay off a debt that will be worth less in the future.

Therefore, in this scenario, investing your extra money in a high-yield savings account or other investment that earns a higher interest rate than your mortgage may make more sense. This way, you can earn a higher return on your money and keep pace with inflation. However, making extra payments may be a smart financial decision if inflation is lower than your interest rate.

Opportunity Cost

Finally, there’s the opportunity cost to consider. Opportunity cost refers to the potential returns you could earn by investing your money elsewhere rather than using it to make extra mortgage payments.

For example, let’s say you have an extra $1,000 per month that you could use to make extra mortgage payments. However, you could also invest that money in a high-yield savings account or other investment that earns a higher return on investment than the interest on your mortgage. Investing your money elsewhere may earn a higher return on your investment and build wealth more quickly.

Before making extra mortgage payments, weigh the benefits against the potential returns you could earn by investing your money elsewhere. Directing your extra payments towards other high-return investments may make more sense rather than using them to pay off your mortgage faster. The decision to make extra mortgage payments depends on your individual financial situation, goals, and risk tolerance.

Get Expert Guidance on Making Extra Mortgage Payments

Making extra mortgage payments can be a great way to pay off your loan faster and save money on interest. However, homeowners should consider all the factors, including prepayment penalties, inflation, and opportunity cost, before making a decision.

If you’re considering making extra mortgage payments, consult with a qualified real estate agent or mortgage professional who can help you determine the best course of action for your individual financial situation and goals. They can help you explore your options and create a personalized plan to achieve your financial goals.

Whether you’re looking to pay off your loan faster, save money on interest, or prepare for retirement, a knowledgeable expert can provide valuable guidance and support.

FastExpert connects you with qualified real estate agents or mortgage professionals who can help you make informed decisions about your mortgage. You can browse profiles, read reviews, and interview potential agents to find the right fit for you. Start with FastExpert and take the first steps toward achieving your financial goals.