Dear Annie,

I managed to save extra money this year because the pandemic reduced my spending. I’m also lucky enough to have gotten a new job that pays more than my previous job. Since interest rates on savings accounts are so low, would it make sense for me to use my savings to pay extra on my mortgage? 

-Jenny

Hi Jenny,

Congratulations on the new job and the additional savings!

Paying extra on your mortgage is a great way to reduce the total amount of interest you will pay over the life of the loan. It can also help you build equity in your home and pay of your loan faster. 

However, it may or may not be the best step for you at this time depending on the terms of the loan and your overall financial situation. 

First cover the basics

1. Have an emergency fund

An emergency fund of 6-9 months of critical living expenses is a must. The pandemic has taught us that jobs are less secure than we thought and it is important to plan for that possibility. 

2. Pay off high-interest debt

If you have any credit card debt or student loans with higher interest rates, those should take priority over paying extra on your mortgage. Click here to get my free debt payoff worksheet delivered to your inbox.

3. Save for retirement

Maximizing your retirement savings takes priority over paying extra on your mortgage. Aim to save 10-15% of your income in a tax-advantaged retirement account (401k, IRA, Roth IRA, etc). This will allow you to get any match offered by your employer and potentially reduce your taxable income. In addition, you will likely be able to earn more in your retirement account through investing than you would get from paying down your mortgage faster. 

4. Protect yourself and your family

Having the right insurance can help protect yourself from catastrophes. Everyone needs health, disability, and home/auto insurance. In addition, those with dependents should have term life insurance. 

5. (Optional) Invest 

Some people choose to invest in a brokerage account because stock market returns generally exceed the amount you’ll save by paying down your mortgage faster. This comes down to personal preference: would you rather gain equity and security faster or increase potential gains? 

Then pay extra on your mortgage

Once you’ve covered the basics, it’s time to figure out the best way to overpay your mortgage. You can:

• Make a lump sum payment

• Make an extra payment each year

• Increase your monthly payment

• A combination of the above

Bankrate.com’s mortgage calculator will show you the effect different overpayment options would have on your mortgage. 

Any option is going to shorten your loan and reduce the amount of interest you pay over the life of the loan. 

From a pure numbers standpoint, paying extra regularly over time will have a larger effect than making a single lump-sum payment. 

Jenny, since you mentioned that your income has increased, you might want to consider allocating that extra income to your mortgage rather than, or in addition to, a lump sum payment. The great news is you’re already accustomed to living on your previous income amount, so you likely wouldn’t notice if you allocated the extra income you now receive toward your mortgage. 

The great news is that there are no wrong answers when it comes to the best way to overpay your mortage, so you can decide what works best for you in relation to your other priorities and life goals. 

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