As you attempt to manage your financial wellbeing, you must do so knowing that handling your debt is always going to be your biggest challenge. It’s not unique to you because everyone who owns a home and car is almost assuredly beholden to at least two lenders. Throw in a little unsecured debt (credit cards), the challenges get a little more difficult with which to deal.
Focusing on your mortgage, that’s a debt you took on at a specific point in time. As your financial status improves over time through employment opportunities or otherwise, you might come to a point where your liquidity offers you some additional financial flexibility. As you contemplate what to do with your extra liquidity, it might occur to you it’s worthwhile to at least consider making extra mortgage principal payments.
In the following sections, the focus is going towards the potential benefits of making extra mortgage principal payments. We’ll also take a quick look at a couple of other ways you can improve your overall debt situation with extra money.
The Benefits of Making Extra Mortgage Principal Payments
Before beginning this discussion, you need to understand that making extra mortgage payments of any kind is not going to affect the principal amount you borrowed. One way or another, you will always have the obligation to pay off the full principal amount of the loan. Also, making extra payments will never affect the amount of your monthly payment requirement. In other words, making an extra principal payment one month will not lower the amount you need to pay on your mortgage payment for any subsequent month.
With that said, there are benefits to be had by making an extra payment.
1. Saving Interest – In theory, the interest you owe each month is calculated on the amount of principal remaining on your mortgage from the previous month. That’s why each fixed monthly payment you make will amortize the loan with a larger portion of the payment going towards the principal with each succeeding month. Of course, the principal portion of the payment will gradually get larger until the last payment is almost all principal.
Now imagine for a moment what happens if you prematurely lower the principal amount with an extra payment(s). Indeed, the principal drops heading into the next month, which will result in the next payment carrying a lesser interest calculation. The next payment will have more of the payment going towards the principal. Even better, the payment amount applied to the principal will be higher every month from that point forward.
2. Shorten the Time You Will Be Making Payments – As we pointed out above, a lower principal amount will result in a lower portion of your monthly payment going towards interest each month. Subsequently, a larger portion will go towards the principal. As a result, you will be paying off principal faster, which should shorten the term of your loan by months if not years. The time it would be shortened by would depend on how much you make in extra mortgage principal payments.
Here’s the good news. Paying an extra $200 a month in principal could result in a savings of tens of thousands of dollars on a mortgage of $300,000, depending on the applicable interest rate.
The only thing you should be wary of is prepayment penalties. Check if your mortgage agreement has such penalties, make sure you understand them, and factor them into your calculations when deciding whether or not to make extra payments.
Other Ways You Can Manage Your Finances With Extra Liquidity
So far, we have focused on using your newfound financial liquidity to save money and time on your mortgage. What if you are a renter or your mortgage is close to being paid off? There are still ways you can use your extra financial flexibility or liquidity to help you better handle your finances.
First, unsecured or credit card debt will always be a threat to your financial security. This is especially true if your credit cards carry a particularly high APR. Any time you have the opportunity to rid yourself of unsecured debt, you need to take that opportunity and immediately improve your financial stability in the process.
Second, it’s real easy to protect yourself from emergencies by pledging to put away additional money into an emergency savings account. If an emergency never comes about, you can always use that extra money to give you something to do on a rainy day.
Finally, you should always have an eye on investing in your future. You should know now that Social Security will not be enough for you in retirement. If you have extra money, you can put that extra money to work by investing it to make even more money for your future. It doesn’t take a lot of money to get started as an investor.
Starting with making extra mortgage principal payments, you should use any extra cash you have to improve your financial standing.
Another way to save on your mortgage is by refinancing. There may be lower rates available than when you originally got your mortgage, and you may be able to get rid of certain extra payments such as mortgage insurance. For expert advice, speak with a mortgage professional in your area. They will give you a more definitive answer about your particular circumstances.