The wrong people are paying off their mortgages

Almost 1 in every 4 homeowners is paying off their mortgage at a rate faster than they're required to - but the people who would benefit the most from this strategy are the ones least likely doing it.

The surprising new data comes from the major lender Rocket Mortgage, which analyzed early payments on nearly 3 million of its loans in all 50 states over the past five years.

The company found that people with the ultralow mortgage rates that were offered in 2020 and 2021 are actually much more likely than those with today's high interest rates to pay off their loans faster than required, a counterintuitive finding that runs against financial advice.

The average extra contribution is equivalent to one additional full monthly mortgage payment per year, Rocket said. On a 30-year loan, that rate of excess repayment could mean shortening the loan by more than five years.

The way a mortgage works is that each monthly payment is a mix of a repayment of some of the loan itself (the principal) and an interest payment. When borrowers make additional payments, those voluntary contributions go entirely toward paying down the principal, not interest. That ultimately reduces the total amount of interest that the borrower will ever have to pay, since the borrower stops accumulating interest on the portion of the principal that's been repaid. Prepaying doesn't just mean paying faster, but actually paying less. It can reduce total interest by tens of thousands of dollars.

But the calculation isn't as simple as thinking that paying more interest is worse. Borrowers who decide to pay extra have to think about how they could have used that money instead.

Interest rates today are much higher than five years ago - not just for home loans, but for bank accounts and investments, too. A person who could hope for a 5 percent return on money they invest in the stock market, but chooses to put that money toward paying off their 3 percent mortgage instead, is losing out on 2 percent of the value.

Indeed, a low mortgage rate is one of the most valuable ways you could free up your money to make better investments. "Financially speaking, if I have a 2.5 percent mortgage, I would rather pay them as slowly and as long as I can," said financial planner Christopher Price.

That's not what Rocket Mortgage's data shows people have actually been doing. Instead, the company found that more than 1 in 4 people who took out mortgages in 2020, when rates were very low, have consistently been making extra payments almost the entire life of their loans, as have nearly as many who started mortgages in 2021. For those who started their mortgages more recently, and thus have interest rates about twice as high, the excess repayment rates are lower, about 1 in 5 borrowers making extra payments.