When you take out a mortgage, you’re agreeing to buy a home on the installment plan — borrowing a large sum, then paying it back over years or even decades. But what if you’d like to settle that debt ahead of schedule?

Prepaying your mortgage means doing just that. Basically, it boils down to sending additional money to your lender to pay down the principal of your loan faster. Not only does it get you out of debt quicker, it will help you save money by reducing interest charges and the total amount of interest you pay in the long run.

Prepaying your mortgage can be a smart financial strategy — if you can afford these extra payments. Here’s how mortgage repayment works, what it means and how to do it.

What does it mean to prepay a mortgage?

Prepaying a mortgage is a fancy term for a simple financial concept: paying off your loan early.

When you pay your mortgage, you send a specific amount to your lender (or mortgage servicer) each month. Your regular mortgage payment includes both the loan principal and interest. The size of these payments (which is usually fixed in the classic 30-year mortgage), and the percentage that goes to principal and interest (which vary over the loan’s lifetime) are figured on your amortization schedule.

When you prepay your mortgage, you’re going above and beyond the regular monthly amount. The money you send is meant to apply directly to the loan principal, not the interest. Of course, if the amount of principal shrinks, the dollar amount of interest on it declines too.

The benefit of paying additional principal on a mortgage isn’t just in reducing the monthly interest expense a bit at a time. It comes from paying down your outstanding loan balance with additional mortgage principal payments, which slashes the total interest you’ll owe over the life of the loan.

How to prepay a mortgage

There are two primary approaches for making extra payments on your mortgage. One involves making two biweekly payments toward your mortgage instead of a single monthly payment. The other involves making an extra monthly payment, or series of them.

Make sure you earmark any additional principal payments to go specifically toward your mortgage principal. Lenders typically have this option online or have a process for only earmarking checks for principal payments. If you don’t specify that the extra payments should go toward the mortgage principal, the additional money will go toward your next monthly mortgage payment, which won’t help you achieve your goal of prepaying your mortgage.

There are several ways to prepay a mortgage:

Make an extra mortgage payment every year

With biweekly mortgage payments, you make a payment toward your mortgage every two weeks. If you pay half of your minimum payment with each payment, you’ll always make your minimum monthly payment.

However, there are 52 weeks in a year and just 12 months. Over the course of a year, you’ll make 26 biweekly payments, which would total the amount of 13 monthly payments. In effect, you make an extra monthly payment each year. The extra money goes toward reducing principal, helping you pay the loan off more quickly.

Add extra dollars to every payment

You can also pay more toward your monthly loan balance. For example, if your loan’s minimum payment is $2,000, you can set up a monthly payment of $2,200. Each month, the extra $200 will pay down your loan’s principal and help you pay it off more quickly.

Apply a windfall lump sum

Come into an unexpected bunch of cash — an income tax refund, a bequest or inheritance, a work bonus or any other type of windfall? Put that lump sum towards your mortgage principal. You can DIY either in a single big monthly payment or bigger biweekly payments. Or, you can choose to shake up your whole mortgage schedule (see below).

Recast your mortgage

Recasting your mortgage works if you have a large sum that you can pay towards your mortgage. Unlike simply making bigger or more frequent payments yourself, a mortgage recast involves your lender, because it involves changing your loan terms.

To recast your mortgage, you will need to put down a certain amount of money in cash or make a specific number of payments. When you do this, the lender then re-amortizes your loan and creates a new schedule of monthly repayments based on the recasting. Your new repayment amount will be paid over the (current) lifetime of the loan based on the lower amount of principal left.

When you recast a mortgage, you will still have the same number of payments, and the same number of years before the mortgage is settled. But because the principal has decreased due to your lump sum payment, your monthly payments will go down.

Lightbulb
Bankrate Insight

Paying down your mortgage at a faster rate helps eliminate private mortgage insurance (PMI) faster, too. The smaller your outstanding principal balance, the bigger your equity stake in your home. On conventional mortgages, once you have built sufficient equity in your home (at least 20 percent), you can ask your lender to remove the PMI.

Example: How much you can save by prepaying your mortgage

Here’s an example of how prepaying saves money and time: Kaylyn takes out a $200,000 mortgage at a 6.5 percent interest rate. The monthly mortgage principal and interest total $1,264. Here’s what happens when Kaylyn makes extra mortgage payments.

Payment method Pay off loan in … Total interest Total interest saved
*Extra $1,264 payment
Minimum every month 30 years $255,089 $0
13 payments a year* 24 years, 1 month $194,725 $60,364
$100 extra every month 24 years, 5 months $199,143 $55,946
$50 extra every month 26 years, 10 months $223,130 $31,959
$25 extra every month 28 years, 3 months $237,857 $17,232

Bankrate’s mortgage amortization schedule calculator can help you determine the impact of extra payments on your mortgage. Click “Show amortization schedule” to reveal the section that allows you to calculate the effect of additional payments.

Use Bankrate’s mortgage payoff calculator to see how much interest you can save by increasing your mortgage payments.

Bottom line on prepaying your mortgage

Prepaying your mortgage can be a good idea in many situations. It can be a big step toward becoming debt-free and greatly reducing your monthly expenses. However, it’s also important to think about the drawbacks.

For starters, tying up your cash in your home means you have less liquidity and wiggle room in your budget to put toward other obligations, like credit card balances or student loans. Mortgages are considered “good debt,” and likely to be lower-cost than other loans, so clearing the high-interest debts might be a better move.

Another consideration is the opportunity cost of not investing that extra money elsewhere, either directly or via 401(k) plan or IRA contributions. Over the past four decades, the stock market has returned, historically, an average of 10 percent a year. It’s always good to reduce debt, but you need your money to be working for you too, and building up a nest egg.

When deciding whether to pay off your mortgage, look at your entire financial picture.Here are some important questions:

  • Is your monthly budget tight after meeting necessary expenses?
  • Is your income variable or unpredictable?
  • How long do you plan to stay in your home?
  • Are you saving enough for retirement?
  • Do you have an adequate emergency savings fund for three to six months of household living expenses?
  • Do you have a lot of high-interest credit cards or loans?

If you answered yes to several of these questions, it may be prudent to wait until you are more financially secure to consider prepaying your mortgage. If you answered no, and your accounts are all in order, it may make financial sense to start a mortgage prepayment plan.