You have signed the papers for a new house and you and your family are living the American dream of homeownership. What could be better? Well, how about when you have paid off the mortgage and your home is yours free and clear? Many home-owners choose to make early mortgage payments. Why is this? Just what are the benefits?
It`s All About The Equity
When Bill Clinton won the US presidency in 1992 he famously said that it was all about the economy. Well, in the case of your home it’s all about the equity. Equity is how much of your home is really yours and not the bank’s. If you had to sell your home tomorrow your equity is the cash you have in hand from the sale after paying off your bank loan and other closing expenses. Your equity is also what you have to apply to the purchase of your next home. If you are hoping to move up in the world to a nicer neighborhood and nicer digs it is all about the equity.
How Do You Build Equity?
Three factors create the equity you have in your home. Your home value in the real estate market hopefully is going up as the market improves. Your equity is the value of your home minus what you owe the lender. No matter what the market is doing you paid a down payment on your home. That is part of your equity because it reduced the size of the loan you had to take out to buy your home. And the principal payments you make every month on your mortgage steadily reduce how much you owe the lender and this increases your equity. When you are in your home you can keep it in good repair which will help maintain its market value. And you can make early mortgage payments to accelerate the growth of your equity in your home. Can you do that and how does that work?
Most lenders will allow you to pay ahead on your mortgage but some will not and some will penalize you for making early payments. This is something to look for when you take out a loan.
When you make early and extra mortgage payments you are paying off the principal, how much you owe. And each time you make an extra payment it also reduces the interest you pay on the next month’s mortgage payment. Mortgage payments are the same every month. As the amount paid for interest goes down the amount paid on principal goes up. This is why in the last years of a mortgage your equity goes up so fast. But, rather than waiting for the last part of a 30-year, 20-year or 15-year mortgage, why not make an extra mortgage payment every quarter or more often as you are able. Your equity in your home will go steadily up and you will pay off your mortgage often-times several years earlier than expected. And, if you go shopping for a home before your current mortgage is paid off you will have more equity from your current home to apply to your next purchase.