Chances are your home mortgage is the largest debt you’ll ever have. How would you like to pay it off and run your mortgage contract through the shredder a lot faster than the 30 years for which most homeowners sign up?
Let’s consider some ways to painlessly pay off your home loan sooner. You can choose to do it a little faster or a lot. In some cases, you’ll scarcely notice the added expense.
1. Make bi-weekly mortgage payments.
Since there are 12 months in a year, homeowners make 12 monthly mortgage payments. But if you make half-sized payments every two weeks (bi-weekly), you’ll make 26 half-payments, the equivalent of 13 full payments.
Essentially, it is like making 13 monthly payments every year rather than the usual 12.
To go this route, call your lender and ask the best way to do it. Some lenders will set you up with biweekly payments. Or you might simply prefer to send in the extra payments by mail or electronically. Whenever you make any extra payment, however, be sure to designate it “apply to principal.” Otherwise, the lender may treat the extra as a prepayment of your next regular monthly payment.
Use a calculator like this one from the Mortgage Professor to see your savings. For example, according to this calculator, if you have a 30-year fixed-rate mortgage at 3.8%, making biweekly payments would save $20,573 in interest over the life of the loan and pay off your mortgage four years earlier. That’s a big bang for not many extra bucks.
One thing to avoid: “mortgage acceleration” products and plans. Paying down your mortgage is an easy thing to do, and you shouldn’t have to pay anything to do it. No expertise or pipeline to a higher authority is required. When you see ads and pitches for mortgage “acceleration” plans, programs and products, run the other direction.
2. Pour every bit of extra cash into your mortgage.
Dedicate every windfall — a bonus, raise, or holiday or graduation gift — you receive toward paying down debt. Obviously, the highest-interest debt takes priority. But if you have an adequate emergency savings fund and your mortgage is your only debt, don’t even ask yourself what you’ll do with extra money when it falls into your hands: Add it to your mortgage payment, designating it as additional principal.
It’s possible you’ll find better uses for extra cash than paying down your mortgage. For example, if your mortgage rate is 3.8%, but you can earn 5% on your money elsewhere, you’re obviously going to be better off earning the 5%. Read Stacy’s discussion about the pros and cons of using extra cash to pay down your mortgage.
3. Round up your payments.
The monthly payment on a $200,000 mortgage at 3.8% fixed over 30 years is about $932 a month. Get into the habit of rounding up that amount to $1,000. Or even $1,030, or $1,050. Do it on a regular basis, and you’ll shave years off your mortgage while feeling little pain.
4. Make one extra payment a year.
Give yourself a holiday gift by making an extra payment at the end of the year — or at any time. Or, if you’d rather, add an amount equal to one-twelfth of your mortgage payment to each month’s payment.
For instance, with the $932 monthly payments in the example above, one-twelfth is $78. Add that to your normal payment, for a total payment of $1,010, and you’ll shave 30 payments off a 30-year mortgage, paying it off in 26 years instead of 30.
5. Refinance into a shorter loan.
Monthly payments are lower on longer-term loans than on shorter-term loans. But borrowers who choose shorter-term loans — such as a 15-year fixed-rate loan instead of a 30-year fixed-rate loan — stand to save a lot of money over the long haul. You can, too.
Follow these three steps to find out what you would save:
- Find current mortgage rates. A good general source is the Freddie Mac weekly mortgage market survey, updated every Thursday.
- Decide if you want a fixed-rate or adjustable-rate mortgage. ARMs are typically cheaper but riskier. Here’s how to decide if an ARM is right for you.
- See what you could save. Use HSH’s amortizing mortgage calculator — choose “show the full table” — to compare the costs and benefits of various options.
Here’s an example: If you pay 3.8% on a 30-year fixed-rate home loan of $200,000, your payment (principal and interest) will be $932 a month. After 30 years, you’ll have repaid the $200,000, plus $135,489 in interest, money that could have gone to a college education for your kids or helped you retire earlier.
Reducing the term, or duration, of the loan usually saves money in two ways: You pay less total interest, and you often get a lower rate.
When I researched this story, the average 30-year fixed-rate mortgage was 3.8%. The average 15-year, fixed-rate mortgage had an average interest rate of just 3.07%. The monthly payments on a $200,000 loan would be $1,388, which is $457 higher than the 30-year version.
But you’d be done in half the time, paying only $49,823 in interest, instead of $135,489. That means you’d keep nearly $86,000 in your pocket rather than putting it in a lender’s.
If you want to shorten your mortgage’s term but 10 or 15 years feels too tight, the payments on a 20-year loan might be more comfortable.
6. Refinance and just pretend it’s a shorter loan
If locking into a shorter mortgage with higher monthly payments feels scary, you can get much the same effect by refinancing — if rates are low enough to justify it — into a cheaper 30-year mortgage but paying it off on a 15-year (or 10-year or 20-year) schedule.
You won’t enjoy the lower rates offered for shorter-term loans, but you’ll save heaps of money on interest. To stick with our sample mortgage, the new payment on your $200,000 (3.8%, 30-year fixed-rate) mortgage is $932. Go ahead and pretend you’re on a shorter schedule. Your monthly payment would be:
- $1,190 to pay it off in 20 years
- $1,459 to pay it off in 15 years
- $2,006 to pay it off in 10 years
Do the math yourself using the HSH calculator, or any number of other free calculators.
This option requires willpower, because you must choose a higher payment than you are required to make each month. But it gives you the flexibility of falling back to your smaller required payment if you need extra cash.
Is refinancing cost-effective?
Options 5 and 6 involve refinancing your home. Before considering those options, decide if refinancing is a good move for you.
Whether refinancing is worth it depends on the associated costs and how long you’ll stay in the home. To be a good deal, you’ll need to stay long enough to more than recoup your costs.
Refinancing is loaded with costs, including, but not limited to:
- A lender’s origination fee
- A title search fee and title insurance
- A settlement professional’s fees
- The cost of pulling your credit report
- An appraisal fee
- State or county tax and/or transfer fees
You can pay for these costs out of pocket at the time you refinance. Many lenders encourage borrowers to have the fees added (“rolled in”) to their loan balance. But if you do, your monthly payment will grow and you’ll pay additional interest.
Another consideration is your credit standing. If your credit isn’t as solid as it was when you first bought the house, you might not get a better rate when refinancing. It’s a good idea to check your credit score and credit report before applying to ensure there aren’t any surprises. (You can get your a free credit score, updated every 14 days, on Credit.com.)
Here’s rule of thumb: Expect to pay 2% to 5% of the loan amount to refinance, says Zillow.
You can shop around by telling several mortgage lenders how much you want to borrow and asking for their estimates of fees.
Tip: Don’t give lenders consent to pull your credit until you’re ready to actually apply for a loan.
This post first appeared on Money Talks News.
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