How to pay down the principal on a mortgage
Quick insights
- You might pay off your mortgage faster by making extra payments; even small ones can shorten your loan timeline and save on interest.
- This strategy works because your future interest is calculated on a smaller remaining balance, saving you money over time.
- In general, you can tell your lender to apply either a specific payment or extra funds in a monthly payment directly to your principal.
Every month, your mortgage payment splits into at least two parts: interest and principal. Your principal is the exact amount you originally borrowed. In the early years of your loan, most of your payment goes toward interest. Only a small fraction actually reduces your principal, but you can pay extra to shorten your loan timeline and potentially save on interest.
Before you send any extra money, review your loan terms and contact your lender. First, confirm that they will apply your extra funds directly to the principal. Second, ask if your loan includes any early payment fees or prepayment penalties. Reviewing your loan terms and speaking with your lender can help to protect you from unexpected charges.
How to make principal-only mortgage payments
Lenders can have slightly different processes for applying a payment directly to your mortgage principal. Below are several general approaches, but check with your lender to make sure your money can be applied to your mortgage how you intend.
1. Make one extra payment every year
Paying just one additional principal payment on your mortgage a year can help take years off the life of your loan. This method reduces the total amount of interest you pay, while helping you fast-track your mortgage payoff. Making one extra payment towards principal every year can be useful in a few situations, including:
- You get a year-end or lump-sum bonus from an employer.
- You receive a tax refund.
- A family member or loved one gifts you money.
2. Make recurring principal-only payments
You don't have to make a large lump-sum payment to reduce your mortgage principal faster. Setting up recurring principal-only payments allows you to chip away at your balance over time, and even modest monthly contributions can add up significantly throughout the year. This strategy may work well if you have a consistent source of extra income, rental income from an investment property, bonuses or other supplemental earnings. By making extra principal payments regularly, you can reduce your loan balance faster and potentially save money on interest.
3. Split your monthly mortgage payment in half and pay that amount every two weeks
If your lender allows this, you could pay down your loan faster by making half mortgage payments every two weeks. During your first month of enrollment, you may need to make both your regular payment and your two half payments. Half payments may be held as “unapplied funds” until a full payment is received. There are usually two months per year when you’ll make an additional half payment. These two extra half payments are applied to your principal, adding up to one full extra payment each year.
For example, rather than making 12 monthly payments of $2,000 for a yearly total of $24,000, you would make 26 biweekly payments of $1,000 for a total of $26,000.
4. Round up your monthly payments to the next $100 and pay the difference
Mortgage payments rarely end in an even multiple of $100 (and zero cents). By rounding up to the next $100 and putting the difference towards principal, you’ll end up paying less in interest. For instance, if your current payment is $1,527 per month, you can pay $1,600 per month. By the end of the year, you’ll have paid $876 extra toward your principal.
5. Use a combination of methods
Today’s lenders tend to accept a variety of methods to pay down your principal. You’re not limited to using only one of the methods above as your income or expenses fluctuate. Depending on your lender, you can pay extra or make principal-only payments whenever you’re able.
Pros and cons of making principal-only payments
Paying down your mortgage principal can reduce interest costs and help you become debt-free sooner, but it’s important to consider the potential benefits and trade-offs before committing extra funds to your loan.
Pros of paying off your mortgage faster
Save on interest
The amount of interest you pay each month is calculated using your principal balance. As your principal balance decreases, your interest also goes down. You could potentially save thousands of dollars in interest over the life of your loan by paying down your principal faster.
You can devote cash to other things
Once you make your final mortgage payment, your cash flow may improve. You can begin funneling the money you were putting toward your mortgage to other things. For example, you can pay off other debts, contribute more to retirement or invest the money.
Safeguard your homeownership
Recessions, pandemics and job loss all have the potential to cause people to fall behind on monthly payments. While homeownership is certainly not a magical solution, paying your mortgage off early eliminates a large expense that you would otherwise face during a crisis.
Access the equity in your home
Once your home has sufficient equity or is paid in full, you may be able to tap into your home's equity. Whether you need to add a mother-in-law suite to accommodate an aging parent or cover other expenses, your chances of being approved for a home equity line of credit (HELOC) can improve when you have sufficient equity or own your home.
Enjoy peace of mind
For many people, the feeling of accomplishment that comes after their payoff is second to none. But paying off a mortgage early also gives you peace of mind. Without the ongoing monthly mortgage payment, you’re a big step closer to financial freedom.
Drawbacks to paying down your mortgage early
Opportunity cost
Every dollar you put toward your mortgage is a dollar you can’t use elsewhere. Depending on your financial goals, that money could be used for travel, home improvements, investing or other purchases and experiences that may provide more immediate value.
Reduced emergency savings
Using extra cash to pay down your mortgage can leave you with less money available for unexpected expenses. An emergency fund can help you cover major costs such as medical bills, home repairs or job loss, without taking on additional debt.
Possible prepayment penalties or fees
Some lenders charge prepayment penalties or other fees when borrowers make large principal payments or pay off a mortgage early. Review your loan documents and contact your lender to understand any restrictions or costs before sending extra payments.
How to make sure extra mortgage payments go towards principal
The key is to specify to your lender that you want your extra payments to be applied to your principal. If you don't make this clear, you may find the extra payment going toward the interest you owe rather than the principal. Regardless of how you make your mortgage payment, here are some suggestions for making extra payments towards principal:
- Online payments: If you’re set up with online banking, sign in to your account and look for a button or option that allows you to make a payment. Many lenders offer the option to put money toward your principal. Select that option and specify your amount and date.
- Phone payments: You can call your lender to make an additional payment toward your principal. Have your account information ready. Most importantly, tell the person you’re speaking with that you want to apply your additional payment to your principal. Make sure to receive confirmation.
- In-person payments: If you feel more comfortable making your payment in person, or if you would like to learn more about additional principal payments, it's a good idea to visit your local branch. Make sure you have a check, cash or your bank account information on hand so they can set up your payment. And don't forget to remind them you want your payment applied to principal.
- Regular mail: Your paper statement typically will include a line item for where you want your excess payment to be applied.
In summary
If you’re eager to find a way to pay off your mortgage faster, talk to a Home Lending Advisor. Whether you're an existing homeowner who wants to pay down your principal faster, or you’re planning to buy your first home, we’re here to help.
There are many ways to pay off your principal faster. A qualified Home Lending Advisor can help you understand the pros and cons of each strategy so you can choose the option that best meets your needs.
