There’s no place like home when it comes to breaking the bank. Buying a home is the biggest purchase most of us will make in life. It starts with signing on the dotted line, which is typically followed by decades of mortgage payments. Interest expenses alone can result in homeowners paying hundreds of thousands of dollars over the life of a loan. However, a variety of strategies are available for those seeking to reduce the shelf life of a mortgage.
Should you pay off your mortgage early? While the decision may be more difficult in recent years due to record low interest rates, many homeowners believe there is no better feeling than being debt-free. Better returns on your money may be found elsewhere, and you lose liquidity by having your money tied up in a house, but reducing interest expenses on your debt is a guaranteed return.
“It’s the sense that a paid-off house means you’re safe and secure. I think the emotional security is one of the biggest advantages to paying off your mortgage early,” said Bob Gavlak, a certified financial planner and wealth adviser at Strategic Wealth Partners, in an interview with The Cheat Sheet. “The financial benefits are there, but the emotional benefit of saying you have an asset that won’t be taken away if the market experiences a downturn is a main advantage.”
Nonetheless, before you start unshackling yourself from a mortgage, it’s generally recommended that you pay off higher-interest debt such as credit cards, build an emergency fund of at least three months’ worth of living expenses, and contribute enough to a 401(k) plan to at least receive any employer match available.
1. Make biweekly payments
While you will likely need to talk to your lender about setting up this method, a biweekly payment plan is the simplest way to shorten your mortgage without a significant budget increase. This plan can reduce your mortgage commitment by about four years by paying half of your regular payment every other week instead of just once a month. This leads to you making 26 biweekly payments every year, which is the equivalent of 13 monthly mortgage payments. The 13th payment is applied to the principal, allowing you to skip ahead on the amortization schedule. On a 30-year fixed rate $270,000 mortgage with an interest rate of 3.625%, you could ultimately save $26,511 in interest.
Instead of setting up biweekly payments with your lender or a third party, you could simply add one-twelfth of your regular mortgage payment to your regular payment. This will also result in 13 payments per year.
2. Refinance and reinvest
Low interest rates not only provide an incentive for you to refinance, but they also make it possible to refinance and pay off your loan early. If you refinance a 30-year mortgage on a home bought five years ago for $300,000 and 10% down, you could save roughly $300 per month. The refinance will set your payoff clock back from 25 years to 30 years, but if you apply the $300 savings toward your new loan each month, you’ll shave 9.5 years off your new mortgage.
Refinancing can be a headache in today’s banking environment, but the costs may be worth the hassle if you can commit to reinvesting the savings toward the new loan. Start by contacting your current mortgage lender to see what rates are available to you and shop around with online services such as LendingTree to ensure you are receiving a competitive rate. Refinancing also costs money, so you need to run the numbers and make sure it makes fiscal sense for you.
3. Increase monthly payments
This is perhaps the most appealing method for those with significant room in the budget — you throw as much extra money at the mortgage as you feel is reasonable. “If you paid $200 extra per month on your 30-year fixed loan at 3.625% on a home purchase of $300,000 with 10% down, you’d save $42,969 in interest and pay off your loan six years and eight months years early. If you paid $300 extra per month, you’d save $57,122 in interest and pay off your loan eight years and 11 months early. And if you paid $400 extra per month, you’d save $68,426 in interest and pay off your loan 10 years and 10 months early.”
4. Consider one-time loan payments
If you can’t commit to regular extra payments, contributing large cash infusions along the way can still reduce your mortgage’s life span. For example, using the same $300,000 purchase price with 10% down scenario, throwing $10,000 toward your loan in year three could save you nearly $16,000 in interest and pay off your mortgage one year and eight months early. Or, if you came into $25,000 in year five and put that toward your mortgage, you could save more than $32,000 in interest and pay off your loan three years and 10 months early.
As Gavlak notes, the method you choose depends on your personal preferences. His clients tend to place extra money in a separate account each month and make a one-time payment toward the principal at the end of the year. This allows for flexibility in case a financial emergency arises during the year. Personal finance is personal, so do what works for you.
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