Prepayment penalties can be equal to a percentage of a mortgage loan amount or the equivalent of a certain number of monthly interest payments. 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 most cases, you can pay your mortgage off early without penalty — but there are a few things to keep in mind before you do: Check for a prepayment penalty: Reach out to your loan servicer to find out if your mortgage has a prepayment penalty.
Most lenders allow you to pay 10% of your mortgage balance as an overpayment per year without penalty. If you're on an SVR (and some trackers). Here you can usually overpay by as much as you want (best to check if you're on a tracker).
If you overpay more than the limit set by your lender or pay off your mortgage early, you may have to pay an early repayment charge (ERC). This amount will vary depending on the lender. It's usually equal to several months of the mortgage's interest, a percentage of the original mortgage value or balance still owed.
Advantage: become debt-free sooner
If your mortgage is your only debt then paying it off is the best way to become debt-free for life.
Often, the cost depends on how far you are into your deal. On a 5-year fixed rate deal, for example, you'll be charged 5% if you leave in your first year, 4% in your second, 3% in the third year, and so on. By way of example, if you had a £200,000 mortgage, it would cost £10,000 to pay off the debt in the first year.
Any lump-sum payment applied against outstanding mortgage principal will lower your interest costs and the number of payments remaining on your loan. So even if you put some of your windfall toward other goals, using the remainder to prepay your mortgage could still save you money. If it makes sense for you, go for it!
If you decide you can't afford your overpayments, you can reduce or stop them at any time and go back to your original monthly mortgage repayment. Paying a lump sum off your mortgage will save you money on interest.
Investing vs paying off debt
Investing broadly remains more profitable than paying off debt. With a 6 per cent average mortgage rate, overpaying a 20-year £200,000 mortgage by £200 a month would enable you to pay it off four years earlier and save about £33,600 in interest owed.
Yes, you can try negotiating it down, but the best way to avoid the fee altogether is to switch to a different loan or a different lender. Since not all lenders charge the same prepayment penalty, make sure to get quotes from different lenders to find the best loan for you.
There's no need to pay off your mortgage by a certain age, although one common rule of thumb says you should pay off your mortgage before you retire. The idea is that getting rid of one of your biggest monthly expenses means you need less income to cover your living expenses.
A 5-4-3-2-1 prepayment penalty, otherwise known as a 5 year stepdown prepayment penalty, charges a 5% fee on the outstanding principal loan balance if the loan is paid off in year 1, a 4% fee in year 2, a 3% fee in year 3, a 2% fee in year 4, and a 1% fee in year 5.
While many with an influx of cash might favor investing rather than paying off their mortgage, paying off your mortgage early can actually save you thousands of dollars in the long run and is often a solid financial decision.
Paying down your mortgage and investing will both result in increasing your savings, but the main difference is that paying down your mortgage will reduce your debt (borrowing) whereas investing will diversify your overall wealth and income.
Making additional principal-only payments on your mortgage can reduce the amount of interest you pay and also help you pay your loan off sooner.
An early repayment charge is a fee to your mortgage lender, which you might be asked to pay if you want to reduce the amount you've borrowed, perhaps by paying off a lump sum.
Paying extra on a mortgage may help reduce the amount of interest paid over time, in addition to the total amount of time it takes to pay back your mortgage.
Why credit scores can drop after paying off a loan. Credit scores are calculated using a specific formula and indicate how likely you are to pay back a loan on time. But while paying off debt is a good thing, it may lower your credit score if it changes your credit mix, credit utilization or average account age.
For one, having one debt paid off means being able to handle any short-term debts such as credit cards. You also end up saving money if you pay off your mortgage earlier, avoiding additional interest that would have otherwise accrued.
Generally speaking, scores between 690 to 719 are considered good in the commonly used 300-850 credit score range. Scores 720 and above are considered excellent, while scores 630 to 689 are considered fair. Scores below 630 fall into the bad credit range.
When it's time to pay off your mortgage, you'll need to get back in touch with your lender and your solicitor. They'll take you through the process, from getting your mortgage redemption statement to handling the title deeds.
If paying off your mortgage is within reach, you can pay it off early by making a lump-sum payment. If you still have five to 10 years of payments, paying a little more each month toward the principal amount will add up to an early payoff.
For savings, aim to keep three to six months' worth of expenses in a high-yield savings account, but note that any amount can be beneficial in a financial emergency. For checking, an ideal amount is generally one to two months' worth of living expenses plus a 30% buffer.