Why do financial planners say to pay extra to your mortgage?

Question

I read articles all the time by financial planners who you want you pay off your mortgage early. That's all well and good but then they make suggestions such as paying extra each month on your mortgage.

There is not benefit to paying extra on your mortgage. The principal and interest are fixed, no matter how much money you throw at them.

You'll pay the same amount every month regardless. If you want to pay off your mortgage early, just put the extra money into savings until you have enough to pay off the mortgage. This way, the money is locked up in your home.

Am I missing something?

Answer 1

The principal and interest are fixed, no matter how much money you throw at them.

This is not correct.

If I pay an extra $1000 in principal this month, then my mortgage balance is decreased. So slightly less interest accrues before my next payment. That means my next payment will be slightly more toward principal and slightly less toward interest than it would have been if I hadn't made an extra principal payment.

This means that my principal will eventually drop to zero earlier than it would have if I had not made the extra payment, and I will end up making fewer total payments than I would have without the extra principal payments. Of course, the effect is even stronger if I make regular extra payments rather than a single one.

Like paying off any debt, you can consider this payment essentially a risk free investment paying whatever is the interest rate on that debt. You know that by making this payment, you reduce your interest payments over the coming years by the interest rate on that amount.

Edit:

In comments you said,

you will pay your mortgage off earlier but you won't drop the amount required to pay each month. Look at a mortgage amortization table to see this.

This isn't because of the amortization table, it's because of the contract terms between you and the lender.

After you make an extra principal payment, a new amortization schedule has to be calculated one way or another. It would be possible to re-calculate a new reduced monthly payment keeping the number of payments remaining fixed. Or you can calculate a new repayment schedule keeping the total monthly payment fixed and reducing the number of payments.

It happens the banks prefer to do the 2nd of these rather than the first, so that's the terms they offer when lending. Perhaps someone more knowledgeable can comment on why they prefer that.

In any case, by reducing your principal you improve your personal balance sheet and build equity in the mortgaged property so that, for example, if you sell you'll keep more of the proceeds and use less to pay off your loan.

Answer 2

but then they make suggestions such as paying extra each month on your mortgage.

How else does one pay off his mortgage early other than by paying extra each month?

The principal and interest are fixed, no matter how much money you throw at them.

The interest rate is fixed.

The total interest paid varies depending on how much extra you pay towards the principal.

You'll pay the same amount every month regardless.

That's factually incorrect.

just put the extra money into savings

At 1.2%, if you're smart enough to put it in an on-line savings account.

until you have enough to pay off the mortgage

Which costs you 3.5%.

This way, the money is locked up in your home.

Who says that all of your money must be locked up in your home? (I'm sure that there are financial advisors who recommend that you throw every single spare dime into extra mortgage payments, but they're rare.)

Am I missing something?

Yes: the mathematical sense to see that a 3.5% loan costs more than than 1.2% savings earns you

Answer 3

By rounding my house payments up to the nearest $50.00, my 30 year mortgage was paid off in 7 years. Initially, my mortgage payment was roughly $600, $50 going to principal and $550 going to interest (banker's profits). By paying $650, I was actually doubling the amount I was paying on principal. Since interest is computed as a function (percentage) of the outstanding principal balance, the amount of my fixed payment that went to interest decreased each month, and the amount that went to principal increased.

In 7 years I owned my home free and clear, and started putting the money I had been putting into the mortgage payments into investments. A rule of thumb I have discovered is that it takes half the time to save money to meet a goal that it takes to pay off the same debt.