1. Not considering all of your options
If you have extra cash to spare, you may be tempted to put that money toward your mortgage and get out sooner. But doing so may not be the best use of the funds. Investing the money into stocks could be a better bet. Over the past 90 years, the S&P 500 has had an annualized return of 10%, a better return than any savings on interest payments.
For instance, say you plan to reduce the mortgage principal by $20,000. On a $200,000 loan, you could shave off $8,300 in interest and pay down the mortgage two-and-a-half years sooner. If you put that same $20,000 in an index fund with an annual rate of return of 9.8%, you could earn $30,900 in interest over 10 years.
2. Skipping extra payments towards the loan principal
You are charged interest based on the principal. So paying down your principal can cut your interest payments. Unfortunately, that only works if your lender knows if the extra money you are paying goes toward the principal. Otherwise, the extra money could be used to reduce the interest payment. Specify to your mortgage provider you want the added dollars to go toward the principal.
3. Forgetting to check if there’s a prepayment penalty
Lenders make money on interest payments, and if you pay your mortgage off early, they will lose money. Bankers are not too happy about that prospect, so they may penalize you. Check to see if you will be charged a prepayment penalty before paying off your mortgage in advance. For example, a 3% prepayment charge on a $250,000 mortgage could cost you $7,500.
4. Failing to have a rainy day fund
The thought of taking one more debt off the table is tantalizing. On the other hand, if you deplete your savings and have no rainy day funds for emergencies, you may regret it.
5. Extending your loan term while refinancing
Refinancing your mortgage can result in savings. If you are thinking of refinancing, consider converting to a shorter rather than the same or longer terms. By converting to a shorter term, you will lower your interest rate and get out from under the mortgage sooner — which is your ultimate goal. Watch out for the closing costs on the refinance. If your lender rolls those fees into the new loan, you could end up with a larger loan amount.
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