Can I Pay Off My Loan Ahead Of Schedule?
Can a loan be paid off early? Most loans allow advance payments to be applied to the principal. Learn more about payment penalties, and lowering the loan cost.
Paying Down a Mortgage Principal
A common piece of advice for homeowners who have a mortgage is that paying down a mortgage early by putting additional funds into the principal balance is a good way to become debt free. However, this method of reducing debt does have its drawbacks. In some cases, paying a mortgage down as quickly as possible would make good financial sense, but this isn’t the case for all homeowners.
Understanding Amortization
When a homeowner begins making payments on a mortgage, the bank or lending institution will create an amortization schedule associated with the loan payments. This schedule will assign a dollar amount paid to the principal as well as the interest for each payment on the loan. Over time the amount of payment paid to the principal will increase while the amount put toward the interest will decrease.
Consequences of Paying a Mortgage Early
It’s vital that a homeowner doesn’t assume that a lower mortgage balance would automatically grant more equity. Debt reduction is an important facet of maintaining a healthy credit rating; however, satisfying a mortgage early isn’t always the best way to use available funds. If a homeowner is well into the mortgage payments on the loan, completing mortgage payments early won’t save an incredible amount on interest because much of the interest was already paid at the beginning of the amortization schedule.
Additionally, the decision to pay extra on a mortgage often requires dipping into savings or investments to engage in larger payments. This strategy isn’t always a good one when the interest gained on those investments would exceed the amount of money paid in interest over the full lifespan of the mortgage.
Loan to Value Ratios and Property Value
Some homeowners seek to improve their loan-to-value ratio (LTV) by paying a mortgage early; however, this strategy doesn’t always result in greater equity. A loan-to-value ratio is the amount of money left to pay on a mortgage compared to the value of the home. For example, a homeowner with a mortgage balance of $70,000 and a home that was worth $100,000 would have a LTV ratio of 70%.
The homeowner could choose to pay that mortgage swiftly to obtain a better ratio, but in the event of a depressed market, efforts at improving the ratio would become futile since it’s likely the house would be worth less in a worse market.
Homeowners who choose to pay their mortgage early must be wary of the financial consequences of such an action. Reducing mortgage debt doesn’t always result in greater equity, nor does it always represent monetary savings.
