The Impact of Extra Mortgage Payments

The web is full of opinions listing the pros and cons of making extra mortgage payments, but there are surprisingly few pieces on how extra payments impact your mortgage payments. Turns out that the answer depends on which of the four main types of mortgage you have. Yahoo Finance gives thoughts on each of these including standard fixed-rate mortgages, standard adjustable-rate mortgages, interest-only mortgages, and home ownership accelerator loans. A few interesting highlights listed from least responsive to most responsive extra-payment home loans:

“Extra payments on a fixed-rate mortgage shortens the payoff period but do not affect the monthly payment.”

“With an ARM on which the borrower is making the fully amortizing payment, extra payments do change the monthly payment, but not until the next rate adjustment. At that point, the payment is recalculated using the reduced balance and the original term.”

“If a loan is interest-only, the payment should decline in the month following an extra payment, whether the loan is fixed-rate or adjustable-rate.”

“The most responsive type of mortgage is the home ownership accelerator, because it has no required payment, only a maximum balance. So long as the actual balance is lower than the maximum, the borrower need make no payment at all.”

And if you’re in the mood for a bit of point-counterpoint today, you can also check out Don’t rush to pay off that mortgage and Paying Off a Mortgage Versus Investing.

Will Making a Large Payment to Principal Reduce Monthly Payments? [Yahoo Finance]

FREE MONEY FINANCE

(Photo: Getty)

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  1. iheartconsumerist says:

    Is it just me or do people completely lack common sense these days when it comes to finances? I’m not sure if it’s because parents don’t show their children how to be responsible with money, or if the school system needs to have classes on this stuff, or if our population is just down right dumb. Its very confusing to me how people can’t see that their buy it now with 0 down attitude won’t eventually catch up with them. In case its not obvious, mortgage companies are in business to make money, car dealerships are in business to make money, if anyone offers you a deal that seems to good to be true you probably should look 5 years down the road because most likely somewhere there is a catch. Unless you are a corporation free money is hard to come buy…

  2. swalve says:

    Nice of him to define what he means by HOA.

    Like anything, it depends. Mortgage debt is some of the cheapest debt you can use. So it’s the last debt you should pay off. And sometimes it’s worthwhile to even keep the debt if you have the cash to pay it off, IF you could invest in something else that yields higher.

    For example- you have a 100,000 mortgage. It costs you, say, 4% a year to keep that debt (interest you pay minus the tax deduction). Now suppose you inherit $100,000. Do you pay off the mortgage or invest it in something? If that investment is going to net you over 4% a year, technically, you’re better off investing than paying off the mortgage.

  3. swalve says:

    @iheartconsumerist: Where do your corporations get this free money you speak of?

  4. zarex42 says:

    @swalve:

    You are absolutely correct. Mortgages are (usually) some of the cheapest debt you can have, second only to student loans, so there is rarely any need to pay them off quickly – they usually should be left alone, and paid as slowly as possible. Hell, inflation’s around 3% a year anyway, so it’s basically free debt. Any dumb money market account can pay over 5% anyhow, so you’re better off keeping the $ in savings than paying down a mortgage.

  5. darkened says:

    @zarex42: Except for being content to know your house is entirely your home and no one short of the IRS will ever be able to pry it out of your hands unless they are cold and dead or you sell it.

  6. SavageATL says:

    I’m wondering- if you are at all concerned about money/savings and have a basic grasp of finance, why would you have any other debt than mortgage/student loans? You should be smart enough to forego the credit card spending, and then smart enough to shop around for a 0%/low interest car loan either from the manufacturer or from a credit union-. Yes, I think you can fool with the numbers to make investing and not paying off a mortgage early come out better on paper but in real life I think it’s harder to do that. Also paying off a mortgage early doesn’t line anyone’s pockets like paying interest on it does, and a lot of people have a vested interest in getting those investment fees. I’m very skeptical that the paper math can be made to work out in real life.

  7. Shadowman615 says:

    @iheartconsumerist: Your comment was interesting, but it really had nothing to do with this article.

  8. pureobscure says:

    I always struggle with advice that advocates investing over paying down a mortgage. My wife and I have a 15 year mortgage at 4.75%. I make extra payments on that every month because I hate debt. I understand that I can make much more than the interest rate on that mortgage. But I also think that people take that approach because mortgages are usually so unfathomably long.

    In a few years time I will be able to take that several grand a month and add it to investments rather than a mortgage. And I can invest that money without worry as much about loss. Investing is still a risk, and it seems to me that paying off your home can be a huge part of your retirement strategy. Someone will never convince me that debt — any debt — is a good thing to have.

  9. “I make extra payments on that every month because I hate debt.”

    We do too. There’s an emotional component to money management, and if paying a little extra on the mortgage each month makes you sleep better at night, it’s worth the tiny (for us) differential between paying it off faster and investing. (We pay enough extra each month to add up to one extra payment a year, so we’re not exactly throwing money at it.)

    I feel like maybe when we reach a critical equity point, I’ll feel like investing that rather than putting it towards the mortgage, but this is my first mortgage and apparently I’m not to that critical equity point yet. :D

  10. swalve says:

    @pureobscure: It’s a tradeoff. Not everyone is in that situation, and not everyoene is going to be able to “beat the market” with investing. My point is only that debt isn’t bad, only mismanaged debt is bad.

    Don’t forget the time value of money. You’ll be richer in 30 years putting $1,000 a year into an IRA rather than putting it toward your mortgage. Even if you pay the mortgage off 7 years sooner, you lost out on all that compounding interest.

  11. swalve says:

    I still want to know where IHEARTCONSUMERIST gets his free corporation money…

  12. goodkitty says:

    @swalve: Though I know I shouldn’t feed you… I would think it’s:
    – Legislation (aka media taxes, subsidies, and other things that allow monopolies or de-facto usage of a privately-owned service)
    – Surcharges and Fees (would you pay someone who painted your house $35 extra because he mailed you an invoice that had a due date 10 days earlier than what you had agreed upon, but he had fine print that said he could change the terms at any time?)
    – Free Money… such as airlines keeping and reselling your ticket if you miss a leg of the flight (from a recent story)
    – I’m Bigger Than You… such as Wal-Mart using leverage to ratchet down vendor pricing and keep employee costs low. (Don’t like it? Don’t do business with us, but wait… you have to if you want to be successful… hah hah hah hah…)

    I’m sure there are lots of other examples of how you can make extra money and even “free” money for doing nothing once you hit a certain critical mass as a business.

  13. MelL says:

    @swalve: Possibly referring to tax loopholes?

  14. Rusted says:

    @darkened: Amen to that.

    The roof over my head is all mine. If business is slow, at least I won’t sleep under a bridge.

  15. anatak says:

    @swalve: so, technically, yes, from a numbers standpoint, in that scenario, you stand to make a few dollars more by not paying off the mortgage. Is it worth it to do that rather than pay off the mortgage from an emotional and risk standpoint? No. Never.

    You’ll be richer in 30 years putting $1,000 a year into an IRA rather than putting it toward your mortgage. Even if you pay the mortgage off 7 years sooner, you lost out on all that compounding interest.

    Thats another easy one to solve: Do both. And yes, that is totally plausible to do once debt-free.

  16. swalve says:

    @goodkitty: Big companies fail all the time. What happened to the free money?

    @anatak: If it’s worth it to you , then it is. Money isn’t everything.

    @anatak: The point of a comparison isn’t really to say “just do both”.

  17. dprboyne says:

    If you have a low or no down-payment mortgage, you have very little equity. There are two reasons you might want to make extra payments, at least at first.

    Reason one: The sooner you reach 20% LTV (loan to value) ratio, you can stop paying PMI (private mortgage insurance). Although it’s not a lot each month, less than $50 for me, it’s money that’s basically protecting the bank from default. It doesn’t do me any good to insure the bank’s assets from default.

    If I make an annual extra payment (which is easy since I’m paid bi-weekly, so 26 half-payments per year, 13 full payments), I’ll be able to stop PMI 3.5 years (42 months) earlier saving over $2,100. That doesn’t even consider the interest savings and loan shortening overall, over $22,000 and 5.75 years in my case.

    Reason two: A low or no down-payment loan means you have small LTV ratio. With so little equity, banks will not give you a home equity loan (or HELOC home equity line of credit), or at least the amount would be small. These loans are attractive because they offer low interest and the interest is tax deductable. And, since you don’t pay any interest on a HELOC until you have a balance, it can be your emergency fund in case you need it.

    Of course, you should already have an emergency fund and home owner’s insurance against potential hazards, or a warranty. But if something major goes wrong, flood, roof collapse, furnace replacement, fire, etc, your emergency fund might not be enough. Even if it is, there will be costs not covered by insurance and it would deplete your emergency fund. What if your basement floods then your furnace goes out two weeks later?

    And these loans can usually be used for most anything, consolidate debt, vacation, home improvement. But if you have low or no equity, this option is not available to you.

    That’s why it might make sense to pay extra on your mortgage for the first few years if you have low or no down-payment