Paying off a mortgage early can save you money, but should you invest the extra cash instead? Find out from Money Girl.
by Laura Adams
Q. I receive a bonus each year and I’d like to use it to pay down my mortgage ahead of schedule. What would save me the most interest, paying the entire amount at once or sending one twelfth each month for a year?
A. The faster you pay down the principal balance on a loan that amortizes, the more interest you can save.
For example, let’s say you have a $200,000, 30-year mortgage with a 5% interest rate. At the end of the third year, you get a $6,000 bonus and sent it in increments of $500 for 12 months to pay down your mortgage early. Even if you never make additional extra payments, you’d save $15,671 in interest over the life of the loan.
On the other hand, if you send the full bonus at once, you’d save a total of $16,149, which is $478 more. Since interest is calculated on your loan balance, the earlier you pay it down the better.
However, in most cases, investing your extra cash is more beneficial than using it to pay down a tax-deductible mortgage. For instance, investing $6,000 in an index mutual fund that pays an average annual return of 6% would give you close to $26,000 after 25 years. So, don’t be too hasty to get rid of your mortgage unless you already have a healthy emergency fund and are saving plenty for retirement!
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