How and Why To Pay Down Your Mortgage

Let’s say, for example, you add $100 to your normal monthly mortgage payment. This makes your loan balance at the end of the month $100 less than it would have been without the extra payment. In the months that follow, you save the interest on that $100 that you otherwise would have paid.

Since the interest payment that you would have made is determined by the interest rate on your mortgage, the yield on your $100 investment is equal to that rate. A prepayment penalty, however, would reduce the yield.

Always make sure your loan does not penalize you for paying early.

To determine whether paying more principal is a good investment, the interest rate should be compared to the yield on alternative investments having minimal risk. Why? There is zero risk on loan repayment.

If your mortgage rate is 6 percent and the alternative yield is a 3 percent earned in a savings account, for example, your future wealth will be greater if you use your excess income to repay principal rather than putting it in the bank. After any period, the reduction in the loan balance would be greater than the increase in the bank account.

If you can safely make a greater return elsewhere, though, invest your money there instead of paying down your mortgage.

Before making any decision on your financial future make sure you see the numbers in black and white and get printouts of all your different scenarios.