Paying off a 30-Year Mortgage Early

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    There was a time when paying down a mortgage or refinancing a 30-year-loan to 15-years was an automatic decision. It was almost always worth it.

    But … that was back in the days of higher interest rates. Now, Bankrate reports that an interest rate on a 30-year loan can be as low as 2.5%. The interest rate on 15-year mortgages is slightly better – 2.25% — but not a significant difference like it was 10 years ago.

    Back in 2010, the borrowing rate for a 30-year mortgage was 5%. A 15-year loan went for 3.8%. Though it was only a 1.2% difference, the total payout was significant.

    If you borrowed $200,000 over 30 years at 5%, the total payout was $386,815. If you borrowed $200,000 over 15 years at 3.8%, the total payout was $262,719.

    That’s a $124,092 savings and 15 years less payments, two great motivators to go from 30-year to 15-year mortgages.

    Today? Not quite as enticing from a dollar-payoff angle. At today’s rates, you save $48,693 by using a 15-year mortgage to pay off a $200,000 loan instead of a 30-year mortgage.

    However, getting out from under a monthly mortgage payment 15 years earlier while building equity in your home faster, could still be enticing, especially for first-time homeowners. Once that mortgage debt is wiped out, money used there could moved to retirement savings or college savings for children.

    In these days of low interest rates, the decision should be thought through carefully. It may well be that wise investing now, can earn more than the interest rate costs. And then there is the tax benefits of owning the home, which should not be ignored. The more careful the process and analysis, the better informed you can be.

    Anyone who is uncertain can find help through a nonprofit credit counselor, who could offer advice on your equity, debts and financial plan.

    Can You Pay Off Your Mortgage Early?

    Lady holding card that says, "Pay off your mortgage"

    In most cases, homeowners can pay off their mortgage early, provided you follow certain ground rules and make sure the terms of your loan.

    The first step is to recognize how your payment works. Early in a 30-year loan, the bulk of the payment goes toward loan interest. As the loan is closer to completion, the bulk goes toward the amount you borrowed, or the principal. But if the principal is lowered through extra early payments, the interest paid also is lowered. Paying down principal in the long run will reduce the total interest paid on the loan.

    The more the principal is paid, the more the homeowner builds equity in the home.  To easily figure the equity, calculate a fair price you feel the home is worth then subtract the loan balance. If a home could be sold for $300,000 and you have $150,000 left on the loan, you have $150,000 in equity.

    When considering paying the mortgage early, be sure you know the answer to a question that many, especially first-time homebuyers, often do not consider: Is there a prepayment penalty on your loan? Many lenders do not have this penalty, but those that do will charge for making early payments. If you have any uncertainty, call your lender to ask specifically about prepayment penalty.

    Once that question is answered, be sure to tell your lender if and when you make extra payments that you want that money applied to principal.

    Finally, don’t overextend yourself to pay extra on the loan, especially in the days of low interest rates. Make sure you have an emergency fund that can pay living expenses for 3-6 months, then make sure credit card debt or student loan debt with an interest rate higher than your mortgage is addressed first.

    Remember, 2.5%-to-2.9% is a historically low interest rate. Carrying that debt is not onerous, so put yourself in good financial position before looking at how to handle the mortgage.

    How to Pay Off a 30-Year Mortgage Faster

    A few options exist as realistic ways to pay off a mortgage sooner than the 30-year term.

    Options to pay off your mortgage faster include:
    • Adding a set amount each month to the payment
    • Making one extra monthly payment each year
    • Changing the loan from 30 years to 15 years
    • Making the loan a bi-weekly loan, meaning payments are made every two weeks instead of monthly.

    There are advantages to each approach. The choice comes down to careful study and a decision based on your financial position and the benefits of paying off a mortgage early.

    Pay Extra Each Month

    The most obvious answer is to take whatever leftover money you have at the end of the month and make an additional principal payment. Attacking the principal with extra monthly payments not only will reduce the amount you owe, but it significantly lowers the amount of interest that you pay over the life of the loan.

    A common strategy is to take your monthly payment, divide it by 12 and make a separate principal only payment at the end of every month. Be sure to label the additional payment “apply to principal.”

    Pay Bi-Weekly

    Simple math explains this approach. A payment a month means 12 payments per year. Paying biweekly means paying half the monthly amount every two weeks. That means 26 half payments, or 13 full payments, which is one extra payment per year.

    This approach could be set up online, which allows borrowers to take advantage of the “set it and forget it” approach (an approach everyone should be using for credit card debt as well). Check with your bank or lender to make sure that it will accept bi-weekly payments as opposed to monthly.

    Make an Extra Mortgage Payment Every Year

    Throw all or a portion of new-found money like a year-end bonus or inheritance at the mortgage. The earlier into the loan you do this, the more of an impact it will have. In a typical 30-year mortgage, about half the total interest you pay will accumulate in the first 10 years of your loan. That is because your interest rate is calculated against the very high principle amount you owe in the early years.

    Refinance with a Shorter-Term Mortgage

    A shorter term on the mortgage means it goes away sooner, but at the cost of a much higher monthly payment – and perhaps some out of pocket closing costs. Examine the loan closely.

    The monthly payment on a 30-year, $200,000 mortgage at 2.5% would be $790 a month.

    The monthly payment on a 15-year, $200,000 mortgage at 2.25 % would be $1,310.

    That’s another $520 a month to finish paying off your mortgage 15 years sooner.

    30 Years vs 15 Years of Payments
    30 Years of Payments15 Years of Payments
    Interest Rate2.5%2.25%
    Monthly Payment$790$1,310
    Total Interest$84,487$35,830
    Total Paid for the Home$284,487$235,830
    *For a $200k mortgage

    The bottom line on this decision is the bottom line: Can you afford the higher monthly payment of a 15-year loan, or are you better off contributing extra each month when you can to a 30-year payment?

    Pay Off Other Debts

    Carefully study and list all debts before deciding how to attack your mortgage. It may well be that you are paying 18% interest in credit card debt and 5% in student loan debt. Wise money management means paying down the debts that carry higher interest rates first, especially with mortgage rates so low. In the end, you’ll save money.

    Debt consolidation also is a wise option if you are carrying several loans. Using a financial adviser or nonprofit counselor to address all your loans and combining them into one into could well save money each month. An acquaintance recently combined a home equity, medical and mortgage loan into one consolidation loan and reduced the interest rate on all three. The result was a savings of almost $400 per month on the total payments.

    Do-It-Yourself Method

    The easiest option may be to come up with your own plan. If it’s affordable, perhaps you add a certain each month, then make one extra payment each year. The advantage to figuring it yourself: If an unforeseen home or medical cost arises, you can merely move the money from mortgage payments to the new debts. If your financial position improves via a raise or new job, you can add more to the mortgage.

    In short, the do-it-yourself plan gives you control over how you approach the mortgage. It’s always better to have destiny in your hands.

    Should You Pay Off Your Mortgage Faster?

    The answer to this question depends on the interest rate for your mortgage. In modern times when the pandemic and slowed economy have pushed interest rates so low, it’s not a bad idea to keep the 30-year mortgage.

    One extra payment per year on a $200,000 loan at 2.75% interest only reduces the mortgage by three years and saves $12,000 in total interest.

    Taking the monthly payment and investing it conservatively means you earn 4% per year on the investment, which means you gain $21,000 in interest over 30 years – which means that by investing you are $9,000 ahead.

    That’s a conservative figure on the investment, but everyone must remember that investment carries risk, and gains may not be steady. That being said, a 30-year loan at 2.75% is as close to free money as we’ve seen in a long time, so any gains on an investment should top that interest rate.

    The surest way to reduce total interest is to transform a 30-year loan into 15 years. However, the budget must be able to afford the extra monthly payment.

    In order, the considerations should go this way:
    • Can I eliminate the debt owed on any loan that has an interest rate higher than my mortgage? If so, do that first.
    • Am I better off funding my retirement? Funding an IRA or 401k is a necessity that cannot be overlooked.
    • Do I have an emergency fund? The pandemic proves anything can happen, so having enough money set aside in case you lose your job is important.
    • If I have children, am I better off funding a college savings account for them or paying down a low-interest mortgage? The answer is almost always funding college, which is an investment in your children’s future, and a tax benefit to you.
    • What do I lose in a tax writeoff if I eliminate my mortgage? This sounds complicated, but it isn’t hard to figure. Simply take your last year’s tax return and see what your tax liability would be without the mortgage writeoff. It may show that keeping the low-interest mortgage is worth the ancillary benefit of a larger tax refund.
    • Once I am otherwise debt-free, is my interest rate high enough that applying extra payments to principal or refinancing is worth it? The old rule of thumb was that reducing the interest rate by 2% made a difference. As the loan amount increases, that number may drop to 1%. But with interest rates so low, it may be wiser to take the extra money and invest It because even a modest rate of return will make you more than the mortgage loan would cost.

    The worst, absolute worst, option would be to take money that could be used in important and vital ways and spending it lavishly on belongings and wasteful material goods. Is it worth buying that extra big-screen TV or more expensive car when it comes at the expense of a secure retirement or a year of college for your son or daughter?

    In the pandemic economy with the Federal Reserve driving the cost of money down, carrying a mortgage with an interest less than 3% is nothing to be afraid of. Instead, it’s an opportunity. Because the lower rate will help buyers more easily get into the home they like and want.

    Once that Is done, treat your financial situation seriously. Save for the future, invest wisely and, when appropriate, address ways to shorten your mortgage. But do so honestly, and with great awareness of the benefits of low mortgage interest rates.

    Max Fay

    Max Fay is an entrepreneurial Millennial whose thoughtful writing shows he has a keen eye on both. Max has a genetic predisposition to being tight with his money and free with financial advice. At 25, he not only knows what an “emergency fund” is, he already has one. He wrote high school and college sports for every major newspaper in Florida while working his way through Florida State University. That experience was motivation to find another way to succeed financially and he has at Debt.org. Max can be reached at mfay@debt.org.

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