Mortgage interest deduction and extra repayments: what you need to know
When carrying a mortgage, most people experience two main components: the interest they owe and the repayment. Reducing debt through additional repayments can lead to significantly reduced monthly expenses. However, there are some limitations and situations in which additional repayments are not always beneficial.
Most lenders only allow an annual additional repayment of up to 10% of the original loan amount. Exceeding this amount can result in penalty interest, as the lender will lose interest income. However, penalty interest only applies if the current interest rate is higher than your current interest rate. For example, if the current interest rate now averages 4%, and your current interest rate is only 2.5%, you may not have to pay penalty interest because the lender can re-lend your repaid amount at a higher interest rate.
Lower risk class and interest rate advantage
In addition to easing your burden, paying off extra on your mortgage can also result in a lower interest rate. However, this only applies to mortgages without a National Mortgage Guarantee (NHG). In such cases, an interest surcharge is charged on top of the basic interest rate, which is higher when your mortgage is closer to the value of the home. Lenders themselves determine the risk classes and associated surcharges. If the extra repayment places your mortgage in a lower risk class, the surcharge will often also be lower, resulting in a more favorable interest rate. On an annual basis, this can make a significant difference in costs.
Consider the pros and cons
While lowering mortgage debt and monthly payments may seem appealing, there are some drawbacks to paying off extra. It is important to consider whether other loans with higher interest rates should be paid off first or whether saving might be more interesting with rising savings rates. Here are the pros and cons of extra repayment listed:
- Your mortgage debt decreases, which can lead to lower monthly payments.
- You may fall into a lower risk class, resulting in a more favorable interest rate.
- The likelihood of residual debt is reduced.
- The amount redeemed cannot be used again.
- Paying off extra can have tax consequences, such as changes in mortgage interest deductions.
Want to know if it's smart to make extra repayments on your mortgage and how best to invest your savings? We would like to help you! Feel free to contact us. Our experts will help you think about alternatives and advise you.
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