Signing a mortgage can be a bittersweet moment. You’re about to lock in your very own home, but you’re also committing to decades of debt.
No wonder so many homeowners are hungry for tips on how to free themselves of mortgage debt as soon as possible.
“The benefit of paying your mortgage off early is you can potentially save thousands of dollars in interest,” said Carolyn Morganbesser, Senior Manager of Mortgage Originations for Affinity Federal Credit Union. “The amount you can save varies by a number of factors, loan amount, interest rate and length of time you have the mortgage.”
Paying off a mortgage early can relieve some financial anxiety but, it’s not always the best move. There are a few questions you should consider before going through with it.
Should You Pay Off a Mortgage Early?
Paying off your mortgage early makes sense if you have enough money saved away that tackling your debt won’t leave you financially insecure. Before whittling down your mortgage, you should have 3-6 months salary saved in an emergency fund.
“If you pay off a large lump sum by liquidating assets, you have lost the ability to use those assets in case of an emergency,” said Morganbesser.
It’s hard to go even a year without some unexpected expense rearing its ugly head, so having money stashed away before paying down your mortgage can help you stay on track when a car accident or plumbing leak or hole in the roof pops up.
You should also ask your lender about any prepayment penalties. They are rare these days, but some lenders do have them and they can be major obstacles when it comes to paying off your mortgage early. Prepayment penalties may be represented as a percentage of the total loan or an equivalent of a certain amount of interest, which could add up to a few thousand dollars.
If you’re paying off your loan to save money on interest, a high enough prepayment penalty could make it pointless. Do the math and see how much you can save before going forward.
What You Need to Know
It’s important to make sure you’re paying down the right debts first. There’s little point in paying off a mortgage early if you have more pressing loans with higher interest rates on deck.
Some borrowers prefer handling their low-balance debts first, hoping these small victories can give them some momentum and motivation to tackle the more daunting balances – called the debt snowball. Others go straight for the high-interest accounts – like credit cards — knowing they will save the most money in the long run by paying these off first – called debt avalanche.
Whatever the case, mortgage debt often falls outside both of these categories. Usually, it’s one of the larger balances you will have and carries some of the lowest interest rates when compared to credit cards, auto loans, and personal loans.
However, every situation is different. In the end, you must decide how important it is to be mortgage-free. Here are the things to keep in mind when coming to a decision:
- Prepayment Penalties: Find out if your mortgage comes with a prepayment penalty. If it does, calculate how much it could cost you. For reference, a 3% prepayment penalty on a $250,000 mortgage would cost you $7,500.
- If you are paying off other debts: You should prioritize your debts by interest rate or loan amount. Don’t repay your debts randomly as you will likely miss out on some money-saving opportunities or shell out more than you needed to.
- Creating an emergency fund to avoid being cash-poor: Before tackling debt, make sure to put away enough money in an emergency fund to handle 3-6 months of necessary expenses.
- Specifying payment be sent to the principal balance: Make sure your extra payments are going directly to the principal and not next month’s interest.
- Consider all other options: Make sure you know why you’re paying off your mortgage early. Don’t just assume it’s in your best interest. Speaking to a professional advisor like a credit counselor can offer more perspective and help you determine if paying off your mortgage early makes sense.
How to Pay Off Your Mortgage Early
No matter how you tackle it, paying off debt early will take time and discipline. However, the method and mindset you approach it with can go a long way in bringing about financial relief.
Here are some strategies for paying off your mortgage early:
Making Extra Payments
Every little bit counts. This sort of advice can sound patronizing, but the effect of putting out a few extra bucks a month towards your mortgage can be highly gratifying. You don’t necessarily need a second job or major windfall. An extra monthly payment of $25-$50, the equivalent of cutting cable, can trim down years of mortgage payments.
“Making additional principal payments each month is the most popular choice as the homeowner has the ability to pay as much or little as their finances allow,” said Morganbesser.
Naturally, the larger your extra payment, the sooner you can pay off your mortgage.
For example, if you were to take out a 30-year mortgage for $200,000 with a 4.5% interest rate, making only the minimum payment would cost you $364,814 in total.
What happens if you throw an extra $100 at the principal each month? Doing this would pay off your mortgage 5 years earlier, and you’d spend a total of $333,068. That’s a savings of $31,746.
Refinance Your Mortgage
Refinancing your mortgage can help you pay it off early in a couple of ways. For starters, refinancing to a shorter term can put you on schedule to repay the loan years sooner. Not to mention the possibility of locking in a lower interest rate that can make it easier to meet or exceed your monthly payment amounts.
Make sure to take any refinancing fees into account as these could make the process more trouble than it’s worth. Also, your monthly payment could be higher – possibly much higher – by moving from a 30-year mortgage to a 15-year.
However, if you’re able to secure a lower interest rate, and you’re confident in your repayment abilities, refinancing can be a great tool to pay off your mortgage early.
Make Payments Towards Your Principal
Making payments directly to the principal of the loan will save you money.
When you send your payment in each month, part of it goes to the principal and part to the interest. Early on, most of your mortgage payment goes towards interest. Towards the end, most of your payment will be going towards the principal.
If you pay down the principal early, you can reduce the amount you spend on interest. This is because interest is calculated as a percentage of the principal amount. A smaller principal amount means less interest will accrue.
Paying down large amounts earlier than later is advised because of the nature of amortization. If you wait to start making extra payments, you already will have lost a good deal to interest. Whereas, by making extra payments from the beginning, you can lop off a good deal of the principal and minimize the amount of interest you pay,
Speak with a Professional
Consider reaching out to a financial advisor or credit counselor for advice. Mortgage amortization can take some time to fully grasp, so working things out on your own may not always be the wisest move. Following general advice may only get you so far when there are nuances that make each person’s situation unique.
Blogs can help you gather information but they may fail to take into account your circumstances and goals. Those can have a major impact on how you should go about paying off your mortgage or any bills, for that matter. Don’t be afraid to reach out to a professional to find out which method aligns best with your interest.
About The Author
Bents Dulcio writes with a humble, field-level view on personal finance. He learned how to cut financial corners while acquiring a B.S. degree in Political Science at Florida State University. Bents has experience with student loans, affordable housing, budgeting to include an auto loan and other personal finance matters that greet all Millennials when they graduate. He has a prodigious appetite for reading, which he helps feed with writing from Scottish philosopher Adam Smith, the “Father of Capitalism.” Bents writing also has been published by JPMorgan Chase, TheSimpleDollar and Interest.com.
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