What you need to know about paying down your mortgage early

You probably know that making extra mortgage payments is a surefire way to reduce your principal and shorten the length of your mortgage.

But, did you know that when and how you make those extra payments can also affect how much you save on your mortgage?

Read on to get the scoop on how to get the most of out of your extra mortgage payments.

Just One Extra Payment a Year Can Drastically Reduce Your Principle

That's right. Making one extra mortgage payment a year can save you thousands, says Sharon McCormick, senior loan officer at Prime Lending in Dallas, Texas

McCormick offers this example:

"For a $200,000, 30-year mortgage at 4.75 percent, the monthly payment is $1043.29," she says. Over the course of the 30-year loan, the total payments (which include principal and interest) would be $375,584.40.

"If the first payment was made in January of 2014, the last payment would be in December of 2043," says McCormick. However, "if you made one extra payment at the end of every year, the loan would be paid off in July of 2039, and you would save an astonishing $29,597.37 in interest," she says.

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If Possible, Time Your Payments to Get the Most Bang for Your Buck

When should you start making extra payments? Our experts say immediately.

"At the outset of a mortgage, the majority of your monthly payment is going towards interest, with only a small amount reducing the principal," says Jonathan K. Duong, CFA, president and founder of Denver Colorado's Wealth Engineers. "Thus, the quicker you can reduce the principal, the less interest you will pay over the life of the loan."

McCormick also emphasizes this point. Because mortgage interest accrues daily, McCormick says that the faster extra payments are applied, the less interest that is due in the future.

"The less interest that is due, the more of your payment that is applied to principle," she says. "It has a "snowball" effect - once set in motion, it continues to build savings."

Duong says the time of year you make your extra payments also has an effect.

"If you can afford to do it, the best time to make an extra payment is early in the year," says Duong. "This will reduce the interest charged for all subsequent mortgage payments."

McCormick also advises homeowners to plan ahead based on future financial changes.

"If you have daycare or student loan payments that will be done in a few years, consider how that extra monthly cash flow could be applied," she suggests. "Again, the sooner the better."

[Want to save on your mortgage? Click to compare interest rates from lenders now.]

Beware: Making Extra Payments Can Cost You

Our experts agree it's important to understand your lender's extra payment policies.

"Contact your lender to ask what their policy is with regards to extra payments made by borrowers," advises Duong. If you don't, you might be served a prepayment penalty.

The Consumer Financial Protection Bureau (CFPB) notes that penalty fees should be laid out in the terms of your mortgage loan.

"Whether your loan carries a prepayment penalty must have been disclosed in your loan documents," notes the CFPB on their website. "Sometimes it is only disclosed in something called the "Addendum to the Note" - look at the Note and anything with "Addendum" in the title."

Even if you're enrolled in an accelerated payment plan through your lender, fees may still apply, warns Duong.

"These plans often carry enrollment fees and transaction charges," he says. To avoid these potential fees, pick up the phone and go through the terms of your mortgage with your lender.

Don't Let Your Extra Payments Sit in an "Unapplied Funds" Account

When making extra payments, make sure to tell your mortgage company exactly how you want the funds applied. "Some lenders will simply hang on to the payment and won't apply it to your loan until the next due date," says Duong.

McCormick says to provide clear instructions via phone, email, or in person. If you don't, you might risk having the money fall into an "unapplied funds" account.

"'Unapplied funds' money that has been collected by your mortgage company has not yet been used for anything," explains McCormick. "When the payment is being made, it is imperative that you indicate that you want the additional funds "applied directly to principle."

McCormick says to check your statement or online account information to ensure the money was correctly applied.

"If it appears to not have been applied to the balance - contact your mortgage lender right away to have it fixed."

The Bottom Line

Overall, you just want to be smart about making those extra payments. Make sure you're not getting charged an early payment fee and always have a clear understanding of where your payments are being applied. Otherwise, your dollar may not stretch as far as it could.

Watch the video below about how a special mortgage deal can help save thousands: