Four ways to pay off your mortgage faster – and save money
Buying a home is a major expense – and a major debt. It’s said it’s the biggest purchase you’ll make in your life. A traditional mortgage loan is repaid over the course of 30 years, but today, some terms call for up to 40 years of repayment. To some, three or four decades seem like an interminable amount of time to take to pay off a debt.
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For those who aren’t looking to change the terms of their mortgage loan, such as refinancing to a lower interest rate or converting a 30-year loan to a 15-year loan, there are a few ways you can put a dent in the principal and lowers the amount of interest paid in the following months and years.
While some folks claim that paying down the principal reduces the mortgage interest available to deduct on your federal tax return if you itemize, in the long run, you’ll still come out ahead. Take into consideration that your tax liability will likely increase incrementally if you’re already in the middle of paying off your mortgage.
Another argument against is that the extra money could be put into investments – but you’d have to make at least the same percentage return as your interest just to break even. Right now, that means playing the stock market or putting money into less-risky savings vehicles, such as CDs, which are barely paying 2% in some places. But don’t forget, these investments are taxable. Your mortgage interest can be used to reduce your tax burden.
If paying off your mortgage early is your aim, always ask if your lender allows prepayments, without penalty. You don’t want to pay toward the principal and get penalized for it. Also be sure your extra money is being put toward the principal, rather next month’s mortgage payment. That won’t reduce your interest payments.
Starting to pay off principal at any point during the term of the mortgage loan will help save you money, but start early on to make the most difference – the first half of the payments go toward interest. After the halfway point, the majority of your monthly payment goes to the principal.
Strategies for paying down the principal:
1. Add principal payments monthly.
Just tacking on an extra $25, $50 or $100 each month can shave years off your mortgage.
Example: For simplicity’s sake, say you’ve just purchased a home for $250,000, and put 20%, or $50,000, down. That leaves you with $200,000 to finance, which you do through a 30-year conventional mortgage at 6% interest. Plug those numbers into Bankrate.com’s mortgage calculator, and the monthly payment is $1,200. The mortgage would be paid in 360 monthly installments over the course of 30 years.
You don’t have to add a ton of money to your monthly payment to make a difference. Making an extra principal payment of $50 monthly, from the very beginning of your loan period, shaves three years off the length of your mortgage. Instead of paying $231,676 in interest (that’s more than the original loan of $200,000!), it will be $203,797 – a savings of $27,879 over the life of the loan. Similar savings can be realized if you start prepayments at any point of the loan.
2. Make yearly principal payments.
Pay a larger chunk of money toward the mortgage once a year. This is even easier if you plan it around your tax refund or annual work bonus, if you get either.
Example: A payment of $1,000 made once a year reduces the term of that same 30-year mortgage by 56 months – almost five years – and saves you a whopping $42,760 in interest.
3. Move to bi-weekly payments.
This has become a popular, simple option. Available through lenders, bi-weekly mortgage payments occur every two weeks, resulting in 26 payments over a year, rather than the traditional monthly payment. It equals a full extra payment each year, but it’s spread out.
Example: Using the same $200,000 loan at 6%, biweekly payments take six full years off your 30-year mortgage, and save you $51,284 in interest.
4. Make lump-sum payments when you can.
Even if you don’t follow a set schedule of making prepayments, throw money at the loan when convenient. If you inherit money or get a tax refund, think about putting it toward your mortgage. Every little bit helps!
Find the mortgage prepayment plan that works best for you, and you can pay off your mortgage sooner rather than later, leaving you sitting pretty and freeing up funds for other things, such as travel, kids’ college tuition, savings, and retirement.
This article was a guest post from Nicole Canfora. Nicole is a freelance writer and editor in the publishing industry with a keen interest in helping others navigate the world of personal finance. Find out more about her at her blog Rainy-Day Saver.
For more on paying off your house early here is another article:
5 Pain-Free Tips For Paying Off Your Mortgage Early!
Paul and Shirley have a 30 year fixed rate mortgage on a $200,000 loan. They are paying 5.5% APR and are motivated to pay that mortgage off early. I applaud their enthusiasm, but I also encourage them to examine their priorities before focusing on their mortgage debt. They should:
- Pay off all other debt. Why? Because getting rid of other debt will free up their cash flow to allow them to attack that mortgage with gusto.
- Save at least a six month emergency fund. Why? Because emergencies WILL happen, and money tied up in their house cannot not be easily accessed to pay for those emergencies.
- Be investing sufficiently for retirement. Why? Because they only have one shot at retirement. They should ask themselves this question, “If my retirement account was already on target, would I sacrifice it in order to pay my house off early?” Of course not, but neglecting their retirement account in order to pay their mortgage early is doing the same thing.
OK? Now, assuming Paul and Shirley have met these guidelines, here are five pain free ways for them to pay off their mortgage early.
1. Make a payment every two weeks.
This approach is especially suited for those who are either paid weekly or bi-weekly because they can synchronize their mortgage payments to their pay schedule instead of the calendar. The strategy works because a payment every two weeks, in a year’s time, will total 26 payments, or the equivalent of 13 monthly payments– one extra payment per year. If Paul and Shirley choose this option, their 30 year mortgage will be gone in slightly less than 25 years.
Note: Many banks, because they are structured to process payments monthly, will not be able to accommodate the bi-weekly payment schedule. However, a diligent borrower can do this on his own by multiplying whatever he is paying now by 1.083 (or 13/12) in order to pay the equivalent of 13 payments a year.
2. Change their W-4 forms, get less refund, and pay extra on their mortgage.
Paul and Shirley, who are receiving a $3,000 refund from the IRS every year, could claim more exemptions on their W-4 forms in order get a smaller refund and more take home pay. If they were to plan for a $600 refund, they would have an extra $200 to add to their mortgage payment each month, lowering their payoff from 30 years to only 21 years.
3. Refinance and keep paying the same payment.
If Paul and Shirley could refinance their loan from 5.5% to 4.5%, and keep making the same payments, they would knock the mortgage out six years sooner.
4. Utilize pay raises.
Paul and Shirley’s current house payment is 25% of their take home pay. If they continue to pay that same 25% as they receive future pay raises, they would be making incrementally bigger payments – a relatively pain free strategy. Assuming these two get a 4% annual pay raise, this tactic would allow them to pay that 30 year mortgage off in slightly over 17 years.
5. Do all four.
What if Paul and Shirley decided to use all of our pain free tips? It would look something like this:
- By changing their W-4 forms, their monthly payment would bump from $1135.61 to $1335.61.
- By paying bi-weekly, their equivalent monthly payment would become $1446.91 ($1335.61 x 1.08333).
- They will refinance to 4.5% with $1000 closing costs, and keep their payment the same ($1446.91).
- They will increase their payment by 25% of whatever ensuing pay raises they receive. We will assume pay raises of 4% annually.
Put it all together, and our happy couple will have paid their 30 year mortgage off in … drum roll please … 12 years and 3 months.
Not bad for some pain free tips on how to pay off your mortgage!
Readers: Have you been trying to pay your mortgage early? What additional tips do you have?