Most lenders will allow customers to prepay mortgages in some form without penalty. Savvy borrowers will take advantage of these options and save themselves thousands without having to try too hard.
For example, taking a bi-weekly payment option alone can drastically reduce the term of a mortgage. Without making any other prepayments, a home buyer borrowing $150,000 at 5% interest can shave 4 off years of a 25-year mortgage just by making a bi-weekly payment. This customer would also save almost $19,000 in interest. The beauty of this approach is that if feels effortless, particularly for those who are paid every two weeks.
Should a person wish to make additional payments, most lenders will allow a certain minimum regular payment or maximum one off payments. Putting an extra $100 per month against the above mortgage will shorten the term by four and a half years and save $25000 in interest. If this is combined with bi-weekly payments, $34000 in interest and 7 years will be taken off the mortgage.
Clearly, prepaying a mortgage will save money in the long run and drastically reduce the term of a home loan. There are further advantages to reducing a mortgage. Each prepayment reduces the principal of the loan. This means that the interest calculations change, as seen in the savings illustration above. If borrowers can see this as an investment equal to the bank’s rate of interest charged on the mortgage, more immediate benefits can be realized. Yes, savings are made long term, but savings are made no matter how long the mortgage is held.
As the principal of the loan is reduced, the equity in the home increases. Home equity is an advantage for several reasons. In the event of sale, homeowners will take in a larger lump sum in the form of net profits. For downsizing purposes this could mean being able to buy and live mortgage free. Also, should a sale not be imminent, a person’s net worth is increased, benefiting for other lending purposes, such as business start up or investment.
Perhaps the biggest advantage of prepaying a mortgage is the ability it gives people to be mortgage free sooner than they would if they just made the regular payments out of habit. Making additional payments, even small ones, habit can reward homeowners with outright ownership years sooner.
Sources:
http://www.hsh.com/calc-amort.html