Every time you make a monthly mortgage payment, a substantial portion of that payment goes towards interest on the loan. The longer the mortgage goes on, the longer that interest continues to accrue. To save money on interest, many homeowners choose to pay off their mortgage early.
But before you move forward with early repayment, you should think about whether or not it’s the right choice for you. Let’s talk about the pros and cons of paying off your mortgage early and some of the ways to go about it. Let’s get started!
Paying Off Your Mortgage Early: Overview
When you first begin paying off your mortgage, most of your payment goes towards the interest. Very little actually goes towards the loan principal – the actual money you borrowed. As the principal slowly shrinks, you accrue less and less interest from month to month. Towards the end of your mortgage term, much more of your monthly payment can go towards the principal.
If you want to pay less over time, you want to pay down more of the principal early on. This will reduce future interest payments, and more of your future payments will be able to go towards the principal. Pay off enough of the principal before it’s due, and you can cut years off your mortgage term, saving thousands of dollars in payments.
For example, let’s say you take out a $200,000 mortgage with a 5% interest rate and a 30-year term. Your monthly payment will be $1,073.64, not including mortgage insurance and other fees. Not bad, right? But when you calculate the total cost, you end up paying $386,511.57 over the course of the loan. That’s $186,511.57 in interest!
Now, imagine you have the same loan, but you pay an extra $100 per month towards the principal. Your total interest payments would drop to $149,442.54, a savings of $37,069.03. Meanwhile, you’d pay off the loan in 24 years and 10 months instead of 30 years.
So, why doesn’t everyone do this?
Simply put, that extra $100 a month could be used for other things. Many financial advisors recommend investing that money instead, since its growth can offset any additional interest you pay. And if you’ve got other, higher-interest debt, it makes more sense to pay that debt first.
In other words, paying your mortgage early is a highly personal decision. Whether or not it’s the right choice depends on your financial situation and philosophy.
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5 Best Ways To Pay Off Your Mortgage Early
There are many reasons to pay off your mortgage early, and not all of them are related to interest. For example, maybe you want to retire early. By paying off your mortgage, you eliminate a significant monthly bill from your budget, which allows you to live on a more limited income without lowering your standard of living.
Regardless of your reasons for making early payments, you’re going to need a plan of action. Here are five ways to pay off your mortgage, reduce your interest payments, and get rid of that monthly mortgage bill.
Make Extra Payments
Refinance Your Mortgage
Recast Your Mortgage
Make Lump-Sum Payments Toward Your Principal
Get A Loan Modification
1. Make Extra Payments
The most straightforward way to speed up your mortgage repayment is to make extra payments. This doesn’t have to be expensive; by paying a little bit more each month, you’ll save a lot of money on interest in the long term.
There are a few ways of making extra payments. One useful method is to split your monthly mortgage payment and pay it biweekly instead. This does two things. First off, since half of your bill is being paid early, you’re getting ahead of the interest and applying more towards the principal. Secondly, by paying biweekly, you end up making an extra half-payment during the year. Since this money is going right to your principal, the mortgage will be paid off faster. The nice thing about this method is that you’re paying the same amount per month, so you won’t have to make many adjustments to your budget.
Another option is to make an extra payment once a year. Pay the same amount as your ordinary monthly bill, and you’re effectively shaving a month off the term of your loan – more, when you consider the interest savings.
Some people will take this extra payment, divide it by 12, and add that month to each monthly payment. For example, if your monthly bill is $1,200, you’d divide that by 12 and get $100. Add $100 to each monthly payment, and pay $1,300 instead. You’re still making an extra payment per year, but you’re only budgeting a little bit each month.
Regardless of how you’re making your extra payments, check with your lender first. Some lenders will apply extra payments as a prepayment on the interest. This can reduce the loan term, but it won’t reduce the total amount you pay. Make sure your lender is applying your extra payments directly to the principal. And if you’re making biweekly payments, make sure your lender accepts them – most lenders will, but it’s best to be sure.
2. Refinance Your Mortgage
If your income has gone up since you started your mortgage, a refinance can be a great way to pay it off faster. You pay off the loan faster when you refinance to a shorter term, which means the interest has less time to accrue.
That said, refinancing to a shorter term will also cause your monthly payments to go up. Talk to your lender first to determine how much you’d pay, and make sure you can afford it before moving forward.
3. Recast Your Mortgage
Mortgage recasting is similar to refinancing, but it works a bit differently. Instead of negotiating a new term, you keep the same term and interest rate, and make a lump sum payment towards the principal. The lender then adjusts the amortization schedule, which lowers your monthly payment.
Mortgage recasting won’t actually pay your mortgage off early, but by lowering your monthly bill, it does reduce the amount of money you pay in interest. Moreover, recasting fees are normally much lower than fees for refinancing – sometimes as low as $200.
4. Make Lump-Sum Payments Toward Your Principal
If you’d rather not recast your mortgage, the next best thing is to make lump-sum payments whenever you can afford it. Many people will take tax refunds, bonuses, and other one-time windfalls and put that money directly into their mortgage. As long as your lender will apply these payments directly to your principal, it’s a great way to shorten your mortgage term.
Moreover, lump-sum payments may be your only option for some loans. VA and FHA loans cannot be recast, which makes this your next best choice.
5. Get A Loan Modification
A loan modification works a bit differently from the other options. Typically, loan modifications are only available for borrowers who cannot make their current payments. Instead of foreclosure, the lender might agree to lower the interest rate, extend the loan term, or make other adjustments to keep the loan current.
Depending on the type of modification, you can end up paying less or even paying the mortgage faster. However, a loan modification can also put a dent in your credit rating. It’s best to avoid a loan modification unless you have no other way to keep up with your mortgage.
Is It Worth Paying Off Your Mortgage Early?
As you can see, there are plenty of ways to pay your mortgage early. But is it worth it for you? A lot depends on your personal financial situation and your level of risk tolerance.
To begin with, repaying your mortgage early comes with opportunity costs. Most mortgages have very low interest rates, sometimes as little as 4%. By comparison, the stock market typically rises by 7-10% per year. If you invested your extra money instead of putting it towards your mortgage, you’d likely end up with more money. Then again, investments can lose value if the economy goes down. On the other hand, early loan payments will permanently reduce your loan principal.
Of course, not all of us are good at investing. If that extra money is going to burn a hole in your pocket, it can be better used by paying down your mortgage.
You should also consider your savings situation. Most financial advisors recommend having at least 3-6 months worth of living expenses in savings, to weather any financial setbacks. If you don’t have an emergency fund, it’s wise to save that money first before putting extra cash into your home.
When Should You Stick To Minimum Payments?
There are certain situations where you don’t want to make extra payments on your mortgage. In addition to the things we just talked about, it’s also wise to focus on paying off higher-interest debt. Credit cards in particular carry substantially higher interest rates than mortgages. So do auto loans, student loans, and just about any other kind of loan. If you’re carrying multiple debts, focus on paying the loans with higher interest first. This will save you the most money in the long run.
Another reason to avoid early payments is if your loan comes with a prepayment penalty. These penalties normally balance out any interest savings, which makes the early payment less helpful. Most loans carry a prepayment penalty, but only for the first few years of the loan. Check with your lender to make sure.
When To Balance Early Mortgage Repayment & Other Financial Responsibilities
The money you pay into your mortgage can be difficult to get back. You can refinance your home or take a home equity loan, but these things take time, and that’s not always an option in an emergency. Make sure you have an emergency fund established before you start paying more money towards your mortgage.
It’s also important not to neglect other financial necessities. You need to be saving for retirement, and if you have kids, you’re probably putting some money into a college fund. All of these things should take priority above early mortgage repayment.
What Happens When You Pay Off Your Mortgage Early?
Whether your mortgage is paid off early or on time, the procedure is the same. To begin with, your lender will mail you a cancelled copy of the promissory note you signed when you took out the mortgage. This canceled document serves as proof that you’ve paid off your debt. Most lenders will also send something called a certificate of satisfaction, but that’s not required.
At this point, you own your house free and clear. But to sell or transfer your home’s title, you’ll need to make sure the lien is removed. Most lenders will do this for you, and your county or city recorder will send you a clean copy of your title in around six to eight weeks. However, some lenders will not provide this service. In this case, you’ll have to call your local recorder’s office and ask them how to have the lien removed. This is typically very easy, and you’ll get a clean title in a few weeks.
To avoid any confusion, it’s wise to find out in advance how your lender handles the lien cancellation. A few months before your mortgage is fully paid, call them up and find out what you’re going to need to do.
You’ll need to contact your local tax assessor’s office to find out how to make your property taxes, since these have been handled as part of your mortgage. Along the same lines, you’ll need to find out how to pay your homeowner’s insurance. When you do this, make sure to have your lender removed from your policy. Otherwise, the lender could receive some or all of the payment if you file a claim.
Paying off your mortgage early is a great way to save money over the long run. Not only will you be done paying your mortgage, but you’ll save oodles of cash in interest payments. It’s important to balance your mortgage payments with your other debts and responsibilities. But for many people, making extra payments is well worth the investment.
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