Paying off your mortgage early can be a smart financial move that saves you money. But there are some important things to consider before you make any extra payments.
The simplest way to pay off your mortgage sooner is to make extra payments each month. This can cut years off your mortgage term and save you thousands of dollars in interest.
1. Make Extra Payments
Some homeowners are eager to get out from under their mortgage early, for reasons that range from eliminating the psychological pressure of debt to slashing interest payments during retirement. But it’s not always the best financial move.
First, you should save enough to cover three to six months of expenses in a savings account. That way, you’ll have money available if you lose your job or face an emergency that forces you to use credit cards.
Then, consider using extra mortgage payments to pay down the principal balance faster. Ideally, you’ll reach a point where the remaining principal is at least 80% of the home’s original value, which allows you to remove private mortgage insurance (PMI) and reduce your overall monthly payment.
You can work backward by calculating your remaining loan term and mortgage interest rate, then adding one additional principal payment each year. Make sure to write a note on your check that specifies the additional payment is intended to reduce principal and not prepay interest for your next scheduled payment.
2. Convert to Bi-Weekly Payments
A popular method is to split your monthly payment into two payments and make them every other week. This results in making 13 mortgage payments a year, which is a huge savings in interest. There are companies that will make this extra payment for you, but talk to your lender first. They may have rules about how long they can hold the money before it is paid to your loan.
Many homeowners also choose to make lump sum payments in order to pay off their mortgage quicker. This is a great option if you receive a large cash infusion each year, such as a tax refund or bonus at work.
This technique can be especially helpful if you are trying to get your mortgage finished before retirement or other life changes. However, you will want to be careful about prepayment penalties that could be included in your mortgage agreement.
3. Make a Lump Sum Payment
If you receive a large sum of money, such as an inheritance, tax refund or commission off a sale, you may want to put it toward your mortgage. Paying off your mortgage early can save you a lot of money in interest payments and allow you to own your home free and clear sooner.
However, there are several things to consider before you make a lump sum payment. For one, your lender will apply any extra money you send to your principal balance unless you specifically request that it be applied only to your interest payments. If you do this, your loan will likely be “recast,” meaning that it will still be paid off by its original due date but you’ll have lower monthly payments.
Also, paying off your mortgage early could negatively impact your credit. This is especially true if you pay off your mortgage with a lump sum from a retirement or investment account.
4. Refinance
Refinancing typically involves trading your existing mortgage loan for a new one. It is a great way to save money with a lower interest rate, pay off the mortgage quicker or cash out home equity. Refinances can be costly, however, so it is important to determine your goals.
For example, homeowners may want to refinance from a 30-year mortgage to a 15-year mortgage because it will help them build home equity faster and pay less in total interest. It’s important to have all your documentation together before refinancing, including paystubs, bank statements, tax filings and W-2s.
Some people choose to refinance to reduce their monthly mortgage payment because of financial issues such as a divorce, job loss or illness. This option will increase your mortgage payment, so it’s important to consider whether it is financially prudent.
It is also advisable to check mortgage refinance rates online before deciding to move forward. There are many lenders to compare and their rates, terms and client satisfaction ratings can vary.
