The Power of Extra Principal and Interest Payments: Unlocking Financial Freedom
7.27.2023 | Category: Article
Achieving financial freedom is a goal shared by many individuals, and one effective strategy to accelerate this journey is harnessing the power of paying extra principal and interest payments. While it may seem counterintuitive to pay more than the minimum required amount on loans or mortgages, this practice can profoundly impact your financial well-being.
Learn the benefits of making extra payments, the mechanics behind their effectiveness, and how they can help you save money and achieve your long-term goals.
Understanding Extra Principal and Interest Payments
When you borrow money through loans or mortgages, the lender provides you with the principal amount, which is the original sum you borrowed. In addition, you are charged interest, which is a fee for borrowing money. The interest is usually calculated based on the outstanding balance of the loan.
Making extra principal payments involves paying more than the minimum required amount each month. These additional payments directly reduce the principal balance of the loan. Interest payments, on the other hand, contribute to the cost of borrowing and are determined by the interest rate and the remaining loan balance.
Considering if Making Extra Payments Makes Financial Sense
Paying extra towards a mortgage payment will not be an ideal strategy for every homeowner. For example, if you’re carrying a large amount of high-interest credit card debt, you might be better off paying down your credit card balances to save money on accruing interest. In addition, if you’re not already saving for an emergency or retirement, you could be better off saving your money in a money market account or investment portfolio.
However, if you’ve already paid down debt and have a healthy savings account, paying extra toward your mortgage payment could be a great next goal for you. An ideal candidate for making extra principal payments on their home mortgage loan would typically be someone who meets the following criteria:
Stable Financial Situation: They have a stable income and are capable of comfortably covering their regular monthly expenses, including the mortgage payment, without struggling financially. Making extra principal payments should not strain their budget or jeopardize their financial stability.
No High-Interest Debt: They have paid off or effectively managed any high-interest debt, such as credit card debt or personal loans. Prioritizing the repayment of high-interest debt is crucial before considering extra mortgage payments.
Emergency Savings: They have established an emergency fund with enough savings to cover unforeseen expenses or financial emergencies. It is important to have a safety net in place before allocating additional funds towards mortgage payments.
Long-Term Homeownership Plans: They intend to remain in the home for an extended period. If you plan to sell your home in the near future, it may not be beneficial to make extra principal payments as you might not have enough time to fully benefit from the interest savings.
Available Cash Flow: They have a surplus of discretionary income after meeting their financial obligations. This extra cash flow can be redirected towards making additional mortgage payments without sacrificing other important financial goals, such as retirement savings or education funds.
Not Planning to Refinance: If there are no immediate plans to refinance the mortgage, making extra principal payments can be highly advantageous. Refinancing can reset the loan term and potentially negate the benefits of the extra payments made.
Benefits of Extra Principal and Interest Payments
Accelerating Loan Repayment: By making extra payments towards the principal, you can significantly reduce the length of your loan. This means you can become debt-free sooner, saving a substantial amount of money on interest payments over the life of the loan.
Interest Savings: Since interest is calculated based on the outstanding loan balance, reducing the principal through extra payments decreases the amount of interest that accrues over time. By doing so, you reduce the overall cost of borrowing and free up your finances for other purposes.
Increased Equity: For homeowners, extra principal payments help build equity in the property. As you reduce the mortgage principal, the difference between the outstanding balance and the market value of your property increases. This can provide a solid foundation for future investments or financial security.
Improved Creditworthiness: Consistently making extra principal and interest payments demonstrates responsible financial behavior. This can positively impact your credit score and improve your overall creditworthiness, enabling you to access better-borrowing terms in the future.
Strategies for Utilizing Extra Payments
Pay More Frequently: Splitting your monthly payment into smaller, more frequent installments can help reduce the impact on your budget and decrease the amount of interest that accrues between payments.
Lump Sum Payments: Whenever you receive a windfall, such as a bonus, tax refund*, or inheritance, consider allocating a portion of it towards extra principal payments. This approach can provide a significant boost in reducing your loan balance.
Bi-Weekly Payments: Instead of making monthly payments, consider switching to bi-weekly payments. By doing so, you make 26 half-payments each year, which effectively results in an extra month's payment. This strategy can significantly shorten the loan term and save on interest.
Refinancing: If you have a high-interest loan, refinancing at a lower interest rate can help you save money on interest payments. Once you've refinanced, continue making extra principal payments to accelerate the payoff process.
The power of extra principal and interest payments should not be underestimated when it comes to achieving financial freedom. By reducing the loan term, saving on interest costs, and building equity, borrowers can pave the way to a brighter financial future.
If you are eager to explore how extra payments can work for you, contact Mutual of Omaha Mortgage today. Our team of experienced professionals is ready to provide guidance and expertise, tailoring a strategy that aligns with your goals.
Together, let's navigate the path toward a debt-free future and make your homeownership dreams a reality. Contact Mutual of Omaha Mortgage now and start saving on interest.
*It is advised to consult with a tax advisor.