Point of Interest
Utilizing free ways to pay your mortgage faster can help you save thousands of dollars in interest while avoiding unnecessary fees or penalties.
If you’ve been wondering, “Should I pay off my mortgage?” you’re not alone. In today’s uncertain market, homeowners are looking for ways to eliminate debt and reduce monthly expenses. While it may seem like a natural choice to pay off the principal loan on your home, not all early payoff methods are created equal. Prior to starting an early repayment plan, it’s important to understand how it works, how much money can be saved and how much it will cost in the long run when you pay off your mortgage faster.
3 ways to pay off a mortgage faster
Mortgage lenders are eager to wave promises of lower monthly payments through attractive refinancing offers, but refinancing may not necessarily help you pay off your loan sooner. Additionally, some mortgage lenders offer specialized accelerated repayment plans that can “force” borrowers to make extra payments under the threat of penalties. While you may have trouble finding the motivation to stick to your goals, locking yourself into an expensive program with your lender is likely not in your best interests.
Instead of looking to your mortgage company to help with your repayment options, consider these free alternative plans for paying off your mortgage faster.
Increase your monthly checks by one-twelfth.
Since there are 12 months in a year, increasing your monthly payments by one-twelfth amounts adds a full extra payment towards your principal balance by the end of the year. If, for example, you had a 25-year loan for $250,000 at 3.75% interest, your monthly payments would be about $1,285.33. Increasing this by one-twelfth would add $107.11 to each payment for a total of $1392.44 per month. If you started the higher payments from the beginning of the loan term, your loan would be repaid 3 years earlier and you would save $18,131.48 in interest over the life of the loan.
Make one extra payment a year
For some borrowers, the monthly budget is already stretched thin. Instead of increasing each monthly payment, a lump sum payment equivalent to one regular monthly payment per year can have a similarly positive effect. This may be ideal for borrowers who receive a tax refund or annual bonus once per year. For example, the same 25-year loan of $250,000 with interest at 3.75% would keep the lower monthly payment of $1,285.33. By paying one extra payment of $1,285.33 each year, a loan amortization schedule with extra payments shows that you would repay the loan 2 years and 11 months earlier and save $17,381.35 in interest.
Pay half of your regular monthly payment to biweekly payments
If you are paid bi-weekly, you may prefer to align your mortgage payments with your paychecks for easier payoff efforts. Instead of paying one large monthly payment, you would pay half of a total monthly payment every other week. Since there are 26 bi-weekly periods per year, this equates to a full extra payment toward the principal loan each year. For a 25-year loan of $250,000 at 3.75% interest, you would pay $642.66 every other week, resulting in early repayment of 2 years and 11 months and a total savings of $17,789.71 in interest.
How much could you save?
Instead of pulling out your mortgage extra payment calculator, consider the following early pay-off scenarios:
|Total Mortgage Loan Amount||Mortgage Term||APR||Extra Payment Amount||Total Savings|
|$300,000||30 years||4%||$119.35 extra per month||$33,397.06|
|$300,000||30 years||4%||$1432.25 extra per year||$32,210.21|
Let’s assume a borrower took a $300,000 home loan for 30 years at 4.0% interest. Their payment under these terms would be $1,432.25 per month and the total amount repaid after 30 years — with principal and interest — would be $515,607.15. A traditional mortgage would cost this borrower over $215,000 in interest over the life of the loan.
With each of the savings tips, the borrower would save considerable interest over the life of the loan.
- If the monthly payments were increased by one-twelfth, the new payment amount would be $1551.60. The loan would be repaid 4 years and 1 month earlier for a total of principal and interest payments of $482,211.46, resulting in a total savings of $33,397.06.
- If he made one extra payment of $1432.25 per year, the loan would be repaid 4 years earlier and the total payments made over the life of the loan would be $483,398.31, resulting in a total savings of $32,310.21.
- If he repaid in bi-weekly payments of $716.12, the loan would be repaid 4 years earlier and the total payments made over the life of the loan would be $482,751.69, resulting in a total savings of $32,856.83.
Keep in mind that mortgage rates can fluctuate and the APR will depend on many different factors such as your credit score, the price of the home, your income and your debt-to-income ratio. Still, the national average mortgage rates have consistently been at or under 3% for several months.
Benefits of paying off your mortgage early
While eliminating your monthly mortgage payment is an obvious benefit of repaying your loan early, there are several additional benefits you may gain from sticking to an aggressive repayment plan. Depending on your loan arrangements, you are likely paying more than the calculated principal and interest on your mortgage. Many mortgages have an escrow arrangement that pays for property taxes, homeowners insurance premiums and private mortgage insurance (if you’re required to pay this). By repaying your loan, you will eliminate your mortgage insurance completely, and you may also have an opportunity to reduce your homeowner’s insurance premiums.
Utilizing an accelerated repayment plan also increases the equity in your home faster and improves your debt-to-income ratio by paying down the loan principal faster. Taking these steps can put you in a better financial position to help you reach any other financial goals you may have.
Downsides of paying off your mortgage early
Although there are many benefits to paying off your mortgage early, there are still some downsides to consider before making that decision. The first potential issue is that it costs money to refinance. You’ll pay similar fees to what you paid for closing costs on your first loan, so if you aren’t planning to stay in your home for a while, the costs could outweigh the savings.
Your money may be better off used elsewhere, too. Most people know whether they will be able to pay this monthly mortgage payment based on their salary, expenses, and other debts. You need to make sure you can afford to pay off your loan early before you commit to it. Don’t stretch yourself too thin if you can’t afford to.
You must ask yourself whether or not that money would be better used for something else. Let’s say, for example, that paying off your mortgage early means you’re not putting as much money into savings for a rainy day. Well, even if your house is paid off, you’ll still need money to pay for unexpected expenses or emergencies.
Or perhaps you could be using that money for other investments instead. If you have a low interest rate, you may be able to make more off of interest from low-risk investments than you would save by paying off your loan early. In that case, it may be smarter to invest the extra money instead.
Refinancing vs. paying your mortgage faster
If you want to lower your mortgage payments but you’re not too keen on the idea of paying off your mortgage faster, then refinancing may be a good option for you. Refinancing is essentially taking out a new mortgage loan with a different rate or terms than your current mortgage.
This could be beneficial to someone who did not get the greatest interest rate or conditions on their mortgage when they first purchased their home. Now their credit is better, though, and the rates are lower, so refinancing would help save money. Refinancing should be considered before you make the decision to pay off your loan quickly.
The downside to refinancing is that it costs you to do so. There are similar fees to what you paid during closing on your original mortgage loan, so you’ll have to do the math to see if it makes sense for you. If you can save enough to justify the costs, you may be better off refinancing with the extra cash you were going to use to pay down your mortgage loan instead.
Refinancing during the COVID-19 pandemic
Many people are choosing to refinance their homes during the COVID-19 pandemic. Most mortgage rates are at an all-time low, and many people are taking advantage of those lower rates to help save money on their loan costs.
Lowering your interest rate by even a point can help save a lot of money in interest over the life of the loan, even if it doesn’t significantly lower your monthly payment. While it can be scary to refinance your home at a time of economic uncertainty, there’s no harm in inquiring about this.
As always, do your due diligence, and remember to read the fine print. Refinancing may be a great option for some people, but it may not be ideal for you. You won’t know until you inquire, though.