April 11, 2011
A frequently-asked question is whether a mortgage borrower receives any benefit from paying before the due date. In most cases, the answer is “no”, but there are a few exceptions. Withsimple interest mortgages, including HELOCs, it does pay to pay early and, under some circ*mstances, paying early in order to shift next year’s interest into this year could reduce taxes.
The Rules When Payments Are Late
On a standard monthly payment mortgage, the payment is due on the first day of the month, and will be credited to the borrower on that day, regardless of when it is received. If the payment is received within the grace period, customarily the first 10 or 15 days, the borrower receives a free ride – no interest accrual – for those days. If the payment is received after the grace period but within the month, the borrower is subject to a late charge. If the payment is not received until the following month, the borrower incurs a late charge and is reported to the credit bureaus as a 30-day delinquency, but the payment is credited as of the first day of the previous month.
When Payments Are Early
Payments made before the due date are also credited as of that date. This gives the lender free use of the borrower’s money for that period. The borrower who consistently pays two weeks early, for example, is in effect providing thelender with a two-week grace period comparable to that provided by the lender to borrowers who pay late. There is no benefit to the borrower.
Simple Interest Mortgages Are Different
On simple interest mortgages, interest accrues daily rather than monthly, which changes the rules significantly. As with standard mortgages, payments are due on the first day of the month and late fees are charged on payments received after the grace period. On simple interest mortgages, however, interest is due every day. This means that a borrower who pays one day late pays additional interest for that day, and the borrower who pays one day early saves a day’s interest.
The bottom line is that a borrower who consistently pays 2 weeks early will save money on a simple interest mortgage. That doesn’t bother the lenders because they know that those are rare birds. Most borrowers pay late.
Borrowers don’t get to choose between standard and simple interest mortgages; I have never heard of it being offered as an option. Most have standard mortgages, and those with simple interest mortgages typically didn’t know what they were getting. Borrowers need to adapt their payment habits to the kind of mortgage that they have.
I should note that HELOCs are simple interest and most HELOC borrowers do understand that they accrue interest daily. It pays to pay early on a HELOC.
Making Advance Provision For Future Payment
Early payment should not be confused with making advance provision for future payments. When I took my family on an around-the-world tour some time ago, I left a set of checks with the loan servicer dated at monthly intervals. This assured that each payment would be made on time, but I was not giving the servicer the use of my money because only one check at a time became negotiable.
A Potential Tax Benefit in Paying Early
In December, some borrowers who itemize their deductions make their payments for the early months of the following year. This shifts the interest deduction in those months from next year to this year. This can be especially advantageous if the borrower expects to be in a lower tax bracket, or expects the tax rate to be lower, next year.
For this to work, however, you need the servicer to agree in advance to credit your account this year for the payments due next year. The end-of-year statement will then show the interest as having been paid this year.
FAQs
In most cases, paying off a loan early can save money, but check first to make sure prepayment penalties, precomputed interest or tax issues don't neutralize this advantage. Paying off credit cards and high-interest personal loans should come first. This will save money and will almost always improve your credit score.
Is early repayment worth it? ›
For personal loans and car finance, early repayment can be an effective way to save some expense if your loan has more than 12 months left of its term. For terms with under 12 months remaining, the amount you have left to pay back in interest might be less than the early repayment charge.
Does paying things early affect credit score? ›
In most cases, you can pay off a personal loan early. Your credit score might drop, but it will typically be minor and temporary. Paying off an installment loan entirely can affect your credit score because of factors like your total debt, credit mix and payment history.
Is there any benefit to paying off a mortgage early? ›
Because mortgages tend to be large loans that last for a couple of decades or longer, paying off the loan early can save you tens of thousands of dollars in interest. Not to mention, it feels good not having a monthly mortgage payment to worry about.
Is it better to pay on time or early? ›
By making an early payment before your billing cycle ends, you can reduce the balance amount the card issuer reports to the credit bureaus. And that means your credit utilization will be lower as well, which can boost your credit scores.
Does paying early help credit score? ›
Paying your credit card early does not affect your credit score in and of itself, but how it impacts your other finances does. If you pay your bill early and lower your credit utilization from 70% to 30%, that can have a positive impact on your credit score.
What is risk of early repayment? ›
Prepayment risk is the risk involved with the premature return of principal on a fixed-income security. When prepayment occurs, investors must reinvest at current market interest rates, which are usually substantially lower. Prepayment risk mostly affects corporate bonds and mortgage-backed securities (MBS).
Does early pay off hurt credit? ›
Paying off the loan early can put you in a situation where you must pay a prepayment penalty, potentially undoing any money you'd save on interest, and it can also impact your credit history.
How to pay off a 30 year mortgage in 10 years? ›
Here are some ways you can pay off your mortgage faster:
- Refinance your mortgage. ...
- Make extra mortgage payments. ...
- Make one extra mortgage payment each year. ...
- Round up your mortgage payments. ...
- Try the dollar-a-month plan. ...
- Use unexpected income. ...
- Benefits of paying mortgage off early.
It's possible that you could see your credit scores drop after fulfilling your payment obligations on a loan or credit card debt. Paying off debt might lower your credit scores if removing the debt affects certain factors like your credit mix, the length of your credit history or your credit utilization ratio.
It might reduce the types, or 'mix,' of credit you have
But now you have one less account, and if all your remaining open accounts are credit cards, that hurts your credit mix. You may see a score dip — even though you did exactly what you agreed to do by paying off the loan.
Does paying immediately affect credit score? ›
Consistently paying off your credit card on time every month is one step toward improving your credit scores. However, credit scores are calculated at different times, so if your score is calculated on a day you have a high balance, this could affect your score even if you pay off the balance in full the next day.
How to pay off a 300k mortgage in 5 years? ›
Increasing your monthly payments, making bi-weekly payments, and making extra principal payments can help accelerate mortgage payoff. Cutting expenses, increasing income, and using windfalls to make lump sum payments can help pay off the mortgage faster.
Is there a negative to paying off a mortgage early? ›
If you're paying off your home loan well in advance, those fees can add up quickly. For example, a 3% prepayment penalty on a $250,000 mortgage would cost you $7,500. In the process of trying to save money by paying off your mortgage early, you could actually lose money if you have to pay a hefty penalty.
Does paying your mortgage twice a month save money? ›
Biweekly mortgage payments
There is an alternative to monthly payments — making half your monthly payment every two weeks. When you make biweekly payments, you could save more money on interest and pay your mortgage down faster than you would by making payments once a month.
Is it better to pay off finance early? ›
If you're able to pay your loan off earlier, you could be saving yourself a lot of money from the interest found across the monthly payments. However, if you're thinking of paying it off sooner and you're in negative equity, you might not want to.
Will my credit score go up if I pay off a loan? ›
While paying off your debts often helps improve your credit scores, this isn't always the case. It's possible that you could see your credit scores drop after fulfilling your payment obligations on a loan or credit card debt. However, that doesn't mean you should ignore what you owe.
Is it better to pay bills early or on time? ›
Paying your bills on time is an important aspect of taking control of your financial life. Knowing when your bills are due and making a habit of paying them by the deadline can reduce your stress, save you money, boost your credit score, and enable you to get lower-interest credit in the future.
What is the penalty for paying off a loan early? ›
However, there are some typical models for determining penalty cost. Percentage of remaining loan balance: The lender will assign a small percentage, such as 2%, of the outstanding principal as a penalty fee if the payoff is made within the first 2 or 3 years of the loan term.
