Reduce Interest Paid
When you add extra principal payments to your mortgage, you reduce the principal owed more quickly. This decreases the amount of interest you will pay over the life of the loan. According to Bankrate.com, if you made just one extra $1,000 payment at the start of a 30 year mortgage at 6.25 percent, you would save more than $5,000 in interest payments over the life of the loan. If, instead of the one-time $1,000 extra payment, you added $20 of principal payments each month, you would decrease your interest by more than $12,000.
Effects on Mortgage Payments
When you make additional payments on your mortgage, your monthly payment will not change. The monthly payment is set when you take out the mortgage and does not change unless you refinance your loan. However, the composition of the payments changes because more of your future monthly payments will go toward paying down the principal instead of paying interest.
Reduce the Mortgage Term
Prepaying what you owe on your home reduces the life of the mortgage. For example, if you had a $200,000 mortgage for 30 years at a 7 percent interest rate and you decided to pay an extra $200 each month, you would cut almost 10 years off the life of the mortgage.
Some mortgages carry prepayment penalties that prevent you from paying off your loan before a specified period of time. These are usually between one and five years and can apply to a certain percentage of the loan or the entire loan. The penalties can amount to about six months of interest payments.
If you are considering prepaying your mortgage, consider the potential return on other investment opportunities. If your mortgage has a low interest rate, consider investing some of your additional payments in a mutual fund or stocks that pay a higher rate of return. For example, if your mortgage charges 6 percent interest and a mutual fund will return 9 percent, you could gain 3 percent by investing in the mutual fund. You also will benefit if you itemize your tax deductions because your mortgage is tax deductible.