Early Mortgage Payoff Calculator 2023

What is an Early Mortgage Payoff?

Over the lifetime of your mortgage, each monthly payment consists of 2 portions. Not only are you paying back the principal amount of your mortgage, but you are also paying off the interest expense of your mortgage for that month. Your interest expense for each month is fixed, so the rest of your payment is used to pay off the principal balance. You can use a mortgage amortization calculator to see how this changes over time.

When making additional payments, make sure to specify to your lender that the payments should be applied to your loan principal. Otherwise, the lender may apply the payments to future interest payments and you will not save on the interest cost from your principal balance. By adding even a small amount to your monthly payment and applying it to your principal balance, 100% of that addition is converted into equity in your home. Essentially, you are “buying” more of your house each month, and since you owe less on your mortgage, you will pay less interest. This process is called accelerated amortization and is one of the easiest ways to pay off your mortgage early.

Are There Other Options?

• Lump-sum payment: Instead of adding to your monthly payments, you may want to pay one large lump-sum towards your principal balance. This can help you save more on interest than if you paid the same amount as accelerated payments. Lump-sum payments may include a prepayment penalty, so you should check with your lender for any associated fees with this method.
• Bi-weekly payments: You can also make mortgage payments every other week by asking if your lender can receive bi-weekly payments or by signing up for a third-party service (make sure to check for hidden fees). At the end of each year, you will have made an additional month’s worth of contributions to your mortgage. You can mimic this technique using an additional monthly payment by adding 1/12th of what you currently pay.

What are the Advantages of an Early Mortgage Payoff?

• Saving on interest costs: Not only does paying off a mortgage early shorten the amortization period of a loan, but you also save a large amount on your interest expense and these interest savings are tax-free. Essentially, you are investing your additional payment at the mortgage rate. Paying off your mortgage early is especially effective if your mortgage is expected to have a high interest rate. This could be because you have a fixed-rate loan with a high interest rate or you have a variable-rate loan and expect interest rates to be high. Use Casaplorer's amortization calculator to understand how the amortization process works and how it affects your interest costs.

  For example, if you have a 30-year fixed-rate mortgage for $300,000 at a mortgage rate of 5% and you make regularly scheduled payments, you will pay $1610 each month for a total of $579,767. However, by paying an additional $100 each month, you would save nearly $40,000 in reduced interest expenses over the lifetime of the loan. You would also reduce the amortization period of your mortgage by almost four years.

• Build up your home equity: If in the future, if you decide to sell your house, you can sell the equity that you purchased. When you make payments towards your principal balance, you are saving that money in your home. By building up this “savings account” and letting your home price increase, you can save for retirement or other future uses.

What are the Disadvantages of an Early Mortgage Payoff?

• Loss of liquidity: You are essentially buying a portion of your house earlier than scheduled. The cash that you use to pay off the mortgage loses its liquidity, however, you can still use a HELOC or future refinance to access this equity. If you abide by the regularly scheduled payments, you will still own your home and the bank just uses it as collateral. Therefore, making early payments does not let you own your home sooner and your cash will be tied up in an illiquid asset.
• Opportunity costs: If you have a low fixed-rate mortgage, investing your money in other assets with a high ROI like the stock market or other real estate would allow you to earn more than saving using early mortgage payments. You would also have access to that money when your investment reaches its maturity and could use it to pay off your mortgage keeping the difference for yourself. If you have an adjustable-rate mortgage and expect mortgage rates to fall, then investing elsewhere is also advisable.
• Losing a tax-deductible expense: Investing in your mortgage to reduce your interest expense may also have downsides. According to the U.S. tax code, interest incurred during your mortgage is tax-deductible for up to $750,000 ($375,000 for individually reporting married taxpayers). If you benefit or can benefit from itemized tax deductions associated with your mortgage interest expense, an early mortgage payoff is inadvisable. You would be investing your cash into an illiquid asset and would lose a tax deduction, which means the tax savings would have their own opportunity cost. Instead, investing elsewhere to receive returns while continuing to claim mortgage interest deductions would be best.

No matter how you decide to handle your money, make sure you have enough money to support your mortgage and other expenses if you lose your job or incur unexpected costs. You should save enough cash to keep up with your scheduled mortgage payments or you could lose your home. Since your home equity is illiquid, you should not consider it as part of your savings.

What is a Prepayment Penalty?

Some lenders will charge a mortgage prepayment penalty if you pay off a large portion of your mortgage within the first few years of your mortgage term. These penalties may also apply if you make a direct payment, refinance, or sell your home. Lenders charge this fee because they would lose potential interest. Most lenders will not charge penalties for accelerated amortization prepayments.

The size of the prepayment penalty can vary between mortgages and it must be disclosed within the fine print of your mortgage agreement. You can also ask your lender directly but you should also check with your mortgage agreement or contract.

Prepayment penalties are illegal and will not apply if you hold the following mortgages:

• FHA loans
• VA loans
• USDA loans

Make sure you understand your mortgage’s prepayment terms and have them explicitly disclosed before you accept a mortgage loan.

What is Refinancing?

Refinancing your mortgage is a viable option that provides more flexibility than adhering to your original mortgage contract. If you can support large additional payments, switching from a 30-year mortgage to a 15-year loan is a common option. Often, mortgages with shorter terms have lower mortgage rates and could save you more than with just early payments. You can reduce a significant amount of your interest expense and pay off your mortgage in half the time. By refinancing to a shorter term, you must make larger monthly payments, which removes your flexibility to only pay more when it is convenient. It is important to understand the conditions associated with your mortgage and how it can be refinanced.