By Jeff Brown
Paying off a mortgage early is a financial strategy people either love or hate, with views often hinging on the prospects of alternative investments like stocks and bonds.
Making extra payments on “principal” – the outstanding debt – reduces the interest paid over the loan’s lifetime, since interest charges are figured each month by multiplying the interest rate by the remaining principal.
Pay an extra $100 in year five of a 30-year, 6 percent mortgage and you’d reduce interest charges over the loan’s life by $344, according to the BankingMyWay.com calculator.
That one extra payment would snowball the same way interest earnings compound in a savings account. Since the monthly payment stays the same for the life of the loan, requiring less for interest means more of each payment goes to principal.
If you paid an extra $100 every month on a $100,000 loan at 6 percent, you’d pay the debt off in 21 years instead of 30, saving nearly $40,000 in interest. (These examples assume a fixed-rate loan, as opposed to an adjustable-rate mortgage.As appealing as these numbers are, making extra principal payments isn’t always the best strategy. Here are some things to keep in mind.
Alternate investments may be better. In effect, the extra payments described above are earning 6 percent a year, since every $100 in payments would save you $6 a year in interest charges. If your mortgage charged 8 percent, your extra payments would be earning 8 percent, and so on.
But if you could earn 10 percent in a mutual fund, stock or other investment, that would be the more profitable choice.