Why should investors consider making additional principal payments?
In addition to helping you pay off your loan more quickly, the main reason investors should consider making additional mortgage payments is it will save money in the long run. In this case, it's all about paying as little loan interest as possible.
Each month, your lender calculates how much interest you owe by taking your outstanding loan balance, multiplying it by your interest rate, and dividing that amount by twelve. Obviously, the lower your remaining loan balance becomes, the less interest you will pay in total.
By the same token, the less loan interest you owe, the greater the percentage of your regular payment that will be applied to your principal balance, which will help you to pay off your mortgage loan even faster.
An accelerated payment example
For the purposes of this example, let's say you have a $185,000 loan principal on a 30-year loan term with a fixed 3.25% interest rate.
Given those numbers, if you simply continue to make your monthly principal and interest payment of $835 per month, you'll end up paying around $98,000 worth of interest on the loan, and you won't pay it off until 2049.
That said, let's imagine you decide to make an extra principal payment worth $1,000 each month for the next five years. In that scenario, you would only owe a total of $44,000 in interest over the life of the loan, and you would be able to pay it off in full by 2038.
The pros and cons of making additional mortgage payments
Although those numbers may make it seem like a no-brainer, there are some pros and cons to making additional mortgage payments. With that in mind, we have laid them out for your consideration below. Read them over so you have a better understanding of whether or not principal reduction is the right move for your investment-property mortgage.
- You can apply the additional payment directly to your principal balance: This means that the benefit of the principal-only payment goes directly to you in the form of added home equity rather than to the lender as an interest payment.
- You'll pay off your loan faster: Making an extra payment will speed up your amortization schedule, which means you can pay off your loan in less time and own the home outright sooner.
- You'll pay less money overall: Putting an extra lump sum toward your mortgage principal reduces the interest charges you'll pay over the life of the loan.
- It will improve your credit score: Paying down your loan balance will reduce your total debt, which will ultimately help raise your credit score.
- You'll still have to make your monthly mortgage payment: If you make an additional principal payment, it won't count towards your monthly payment, which means you'll still have to be prepared to make your regular payment by its due date.
- You may face a prepayment penalty: Some mortgages come with a prepayment penalty, which is a fee that might be added to your final payment if you pay off your loan early.
The bottom line on principal reduction
If you can swing spending the extra money, making extra principal payments can be a savvy financial decision. For one, it can help you pay off your mortgage loan faster. Further, it can help you save money overall. With that in mind, use this as your guide to principal reduction.