Q: I took a short term job with a substantial increase in pay and would like to apply the extra money to my mortgage. Is it more beneficial to pay an extra amount each month or should I hold onto the cash and pay a large lump sum each year?
And if I make one lump sum payment annually, does it matter when I send in the payment?
A: Here’s the short answer: When it comes to paying down any sort of debt, the sooner you make an extra payment to your loan, the less interest you’ll pay over the life of your loan and the faster you’ll pay it off. Let’s take a look at how this works:
Let’s assume you have $6,000 extra in cash each year to prepay your mortgage, and you have just closed on a 30-year $200,000 fixed-rate mortgage at 6.5 percent. If you prepay your mortgage by $500 per month, you’ll pay off your mortgage in 15 years, and pay $110,940 in interest. But if you make a $6,000 payment once a year, at the end of the year, it will take a few months longer to pay off the loan and you’ll shell out an extra $5,000 in interest. If you make the payment in the middle of the year, you’ll just about break even with the monthly prepayments. And if you pay the lump sum each year at the beginning of the year, you’ll save a few thousand dollars extra.
Of course, if you have that much extra cash to prepay your mortgage and you are shopping for a new mortgage you’re best off getting a 15-year loan to start off with, because the interest rate you’ll pay will generally be lower than you could get on a 30-year mortgage. But if you have a great rate now, and don’t want to incur the costs of refinancing, then you should start adding an extra amount to your mortgage check each month. Just be sure you tick off the box that indicates the overage is to be put toward the remaining balance (the prepayment of the loan).