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Prepayment Options

February 21, 2012

A popular feature of the fixed-rate mortgage is the opportunity to “prepay” without the fear of penalty. The ability to prepay allows the borrower to reduce the principal balance without incurring a penalty, as is sometimes the case with some adjustable-rate mortgages, depending on the terms of the agreement.

If a borrower exercises the option to prepay, he/she accelerates the amortization of the loan by paying more toward the principal early in the loan, which decreases the total amount of interest paid on the loan. As mentioned earlier, the normal amortization of a fixed-rate mortgage, especially with a 30-year term, applies the majority of the initial payments toward interest rather than the principal loan balance.

Prepayment is achieved by paying an amount on top of the required monthly payment. Because this amount is in addition to the amount required to repay the loan, the result will be the loan being paid off before the loan schedule. The amount of the scheduled monthly payments remains the same, so any additional amount paid results in the acceleration of the loan and savings on interest costs. Though this practice is more common with fixed-rate loans, it is still possible for borrowers to execute a prepayment option on an adjustable-rate loan, depending on the agreed upon terms.

Effect of Monthly Prepayment on Loan Term
Loan Amount $100,000
Interest Rate 7.50%
Amortization (Term) 30
Principal and Interest $699.21
Extra Monthly Prepayment Amount Total Payment with Prepayment Loan Term in Months After Extra Payment Loan Term in Years After Extra Payment Total of Payments as Scheduled Interest Savings
$0 $699.21 360 30 $251,717.22 $0
$20 $719.21 326 27.19 $234,628.57 $17,088.66
$50 $749.21 288 24.04 $216,090.81 $35,626.41
$75 $774.21 264 22.02 $204,593.15 $47,124.07
$100 $799.21 244 20.37 $195,405.93 $56,311.29
$150 $849.21 214 17.81 $181,510.92 $70,206.30
$200 $899.21 191 15.88 $171,400.91 $80,316.31

Bi-weekly payments

In addition to monthly prepayment strategies, bi-weekly mortgage payments are also a viable option. As with any prepayment strategy, bi-weekly mortgage payments reduce the term of the loan, reduce interest payments, and apply more to the principal loan balance. Bi-weekly payments are equivalent to making one extra mortgage payment per year because there are 26 bi-weekly periods in a year (13 monthly payments). Taking advantage of an “extra” payment each year of a 30-year mortgage would reduce the term to 24.5 years.

Just as with the terms of any loan agreement, there are benefits as well as drawbacks. Though the term of the loan is shortened by making bi-weekly payments, many loan servicers apply the mid-month payment only after the full monthly payment has been received. As a result, there are no additional interest savings from a mid-month principal reduction. That being said, bi-weekly payments remain a popular prepayment option because they can be applied to fixed-rate as well as adjustable-rate mortgages that allow for the borrower to pay every two weeks, without penalty.

Other potential drawbacks that should be considered by the borrower with regard to his/her financial situation and needs are as follows:
There is a greater potential for late payments (twice as many payments to make)
The rates for the bi-weekly loan are often not as competitive as those for standard monthly plans
Lenders may charge a fee for administering the bi-weekly program

FOR A FAST PRE-APPROVAL: 
http://pmcmortgageloans.com/mortgage_application.php

First, Complete out a loan application on our website
-Go to http://www.pmcmortgageloans.com
-Click on Apply Now at the top
-Scroll to the middle of the page and Click on 3. Full Application
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