4/11/2013 4:45 PM ET|
4 ways to pay off your mortgage early
If you're able to swing it, paying down your home loan ahead of schedule can save you big money. What's the best way to go about it?
Paying off the mortgage early is in. Refinancing to take money out of your home is out. Having lived through the foreclosure crisis, more people want the security and the psychological benefit of owning their home free and clear.
If you want to pay off your mortgage early, you'll find plenty of experts recommending ways to do it. All strategies work, but you'll find some methods of paying down your mortgage are safer, faster and more painless than others.
Compare these four ways you can pay off your mortgage early, starting with the simplest and moving toward the most complex.
Just pay more
If you want to see magic, start playing with mortgage calculators and see how adding a little payment to your principal here and there can shorten the length of your loan. You can use Bankrate.com's mortgage loan payoff calculator to see how $100 or any other amount added to your payment reduces your interest and shortens the length of your loan.
If you pay a little more principal, you get a bonus. The lower your principal gets, the more every payment from then on is applied to principal, as less goes to cover interest expense.
If nothing else, round your payments up, recommends Tracy Piercy, CFP and CEO of MoneyMinding.com. She says that when people have a payment for $644, they think of it as $650. Why not just pay $650, then? An extra $6 a month on a $200,000, 30-year loan can save you four payments at the end of the mortgage loan.
When you pay extra, make sure the extra is applied to the principal balance, not just set aside for the next payment. And before you make extra payments, read your contract and make sure you won't have to pay prepayment penalties.
Refinance to a shorter-term loan
You can refinance into a mortgage for 10, 15 or 20 years, but 15-year mortgages are the most common. Your payments will be higher on a 15-year loan, but perhaps not as high as you think, especially since they often offer lower interest rates.
One advantage of a 15-year loan is that you're committed to the higher payment. There's no dithering about whether you can afford to pay extra this month.
With a 30-year, $100,000 loan at 5 percent, your principal and interest payments are $537. At the same rate, but on a 15-year payoff schedule, your principal and interest payments are $791. That's $254 more a month.
To get the effect of a shorter-term mortgage without the risk, take out a 30-year loan, but make payments as if you had a 10- or 15-year loan. "You just make increased payments. You're in control, not the bank," Piercy says.
Bankrate.com's 15- or 30-year mortgage calculator can help you compare loans.
Switch to biweekly payments
Biweekly payments take advantage of the fact that there are 52 weeks in the year and 12 months. If you pay half your regular mortgage payment every other week, you'll have made 26 half-payments, or the equivalent of 13 full monthly payments, at year's end.
See how it works with Bankrate's biweekly mortgage calculator. The extra annual payment can chop off about six years from a 30-year mortgage.
You shouldn't have to pay an outside company to set it up for you. "I hate the idea of having to pay a third party for something the consumer(s) can do on their own," says Cathy Pareto, MBA, a Certified Financial Planner in Coral Gables, Fla. "Why pay the extra fees if you can avoid them and still accomplish the same goal?"
Check if your bank will set up a biweekly payment plan. Some banks do it for free; others charge. Ask the bank to credit extra payments toward principal so you save more on interest expense. Some banks set aside extra payments until the end of the year.
Use a money merge account (the Australian method)
In Australia, mortgages are generally set up like home equity lines of credit, or HELOCs. They double as checking accounts, thus the term "money merge." When you get paid, you deposit your check into the account, and as you spend money you take it back out again. You hope to put more money in every month than you take out.
With a mortgage using the Australian method, interest is calculated daily instead of monthly, and because the money spends as much time as possible in the account before you take it back out to pay bills, you save on interest expense.
Some money merge programs require you to buy software for thousands of dollars. However, there's no magic formula for shifting your money around. "You don't need software to do that," Piercy says.
The biggest downside to the money merge plan is that it requires discipline. "You wouldn't do it unless you understood cash management," Piercy says.
More from Bankrate.com:
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One thing you have to remember about making extra payments is that no matter how much extra you give the bank each month, they still want the regular payment the next month.
I agree that you have to live a little in the present. Time on this earth is not guaranteed. Live in the now, plan for the future, and hope for the best.
I'll have mine paid off next year, 10 years early. it takes discipline and sacrifice, but well worth it!
Essentially, live within your means. After all obligations are met each month, save/invest 15% of your net pay.
By living at least slightly below your means, you will be inclined to have financial stability and the peace of mind that accompanies it.
Of course, Ramsey is 100% right about not keeping up with your neighbors and not wasting your money on "status symbols" like high-end cars, etc. But one thing to consider is the liquidity of your total estate. Cash is obviously the most liquid while real estate (your house) is probably the least.
You want to develop a tiered approach that allows you to have enough liquid assets so that you can: 1.) take advantage of excellent, higher yielding investment opportunities; and 2.) have access to your wealth in the event of extreme emergencies (IE- you lose your job and health care, then suffer a heart attack -- that will cost you about $200K out of pocket and if it's all locked up in your house, guess what...).
Best to learn as much as you possibly can about finance, then hire a good, reputable, honest and trustworthy financial planner to help you develop a solid plan. He/she may be hard to find, but in the end it will be worth it.
I always had people telling me to refinance but I didn't think that was best.
I paid as much extra on my payment each month as I felt I could and avoided the refinancing charges.
Just because interest rates go down it looks good to do a refinance but it can cost you a big chunk of your savings in fees.
I always noted on my check that any extra above the normal payment to be applied to the principal to be sure I was getting the full amount paid down on the principal and not taxes or interest.
And a paid-off mortgage is a great advantage in retirement: without it you may have to live like a miser then without choice. I had a leg problem that I suffered through for a few years of work to make sure I was set for retirement. Because I had refinanced and shortened my mortgage, I paid it off within months of retiring early at 56.
years ago i read that making 13 payments a year turns a 30 year loan into a 15 year loan. i reviewed it on a spreadsheet and sure enough - it's not that hard to pay a little more to rooll back the years of a loan.
so i made extra payments.
and i rolled the first house equity into a second, then the second equity into a third home. now the third home will be paid in full in year number 15. roughly 30 years from the time i bought the first home.
My wife and I did that years ago. One of the things we did to make it easier was rent rooms out in our house. Now this isn't for everybody but we talked about it and then decided to go for it. It worked out great! House was paid off in less then 9 years using the money from rent plus adding everything we could to the payment.
It not easy but it can be done.
All of this is a lot easier than it sounds. After paying extra toward my principal for an entire year (AND indicating that the extra as being towards principal by checking the box on the payment slip) I was shocked when CountrySlime sent me a refund check; they put ALL of it in escrow! I was pretty steamed. After they went belly up and were swallowed up by BAC, I was wise to these dirty tricks. But BAC just sold my mortgage to another fly by night company that does NOT have it marked anywhere on the form that the extra amount is expressly intended to be applied to principal.
I think it would be nice if all these two bit mortgage charlatans were investigated to within an inch of their lives, but unfortunately, of course, they own Congress anyway so that will never happen.
So. Yeah. Nice idea in "principal", but we still end up getting screwed even when we try to be responsible...
I bought a home in 1991 and two years later the interest rates dropped from 9.5% to less than 7% and everyone was refinancing. The "experts" said to take a 30-year mortgage instead of a 15-year mortgage and invest the difference and you'd do better. The problem, of course, is that most people would find a "need" for most or all of the difference before it makes its way into an investment.
What pushed me into a 15-year mortgage was an episode of CNBC's "Your Portfolio" where Jimmy Rogers and Bill Griffeth were trying to talk a Pittsburgh musician of irregular income into a 30-year mortgage. "No," he insisted, "That home is the bedrock of my financial security and I want to own it free-and-clear ASAP."
I was within 9 months of paying the mortgage off when leg problems pushed me to take an early retirement - for which I was prepared to live comfortably partly because the mortgage would soon be gone!
Compounding can work for you or against you. When you lend, it's working for you. When you borrow, it's working against you. That's the simple version, but if more people would learn it before age 30, they individually and the country as a whole would be better off.
The intermediate-level version is that if you can lend and borrow roughly equivalent amounts at roughly equivalent maturities (usually long-term), but lending at a slightly higher rate than the rate at which you borrow, you will maintain a positive interest rate spread over the life of those loans and come out ahead. You'll be thinking like a well-functioning bank, and as an economics professor of mine once said, "Good times or bad, [well-run and prudent] banks make money."
The advanced version is learning to insure against the inevitable uncertainties and disruptions that, if they become severe or prolonged enough, might derail the simple and intermediate versions. But I haven't mastered this level yet, so I will leave the explanation to those who have.
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