Can I Pay Off My Mortgage Early? - What To Expect
Paying off your mortgage early can save you thousands of dollars in interest payments and shorten the life of your loan. While most lenders allow you to pay off your mortgage early without a prepayment penalty, some do charge extra fees. Before you pay a mortgage early, you'll want to check your lender's stipulations and evaluate your financial options.
Just because you can make extra mortgage payments doesn't mean you should.
That said, several reasons are paying your mortgage early can work in your favour. If you want to retire early, become debt-free, or save money, paying more toward your mortgage's principal balance is a sound strategy. Here are some common ways you can accelerate your payment schedule.
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Make Biweekly Payments
Most mortgage lenders let you set up biweekly payments on your mortgage loan. Verify whether your lender charges a prepayment penalty or fee to do this. If the lender doesn't, you can schedule extra payments by submitting half of your mortgage payment on a biweekly schedule.
Say your regular monthly payment is $1,500. This includes your principal balance and interest. With biweekly payments, you'll pay $750 every two weeks. This small change brings your mortgage ahead by an extra monthly payment each year. Your accumulated mortgage interest and loan term will also go down.
Making additional payments won't reduce your interest rate but it can shave two to three years off your loan term. You can also save tens of thousands in interest over the life of your home loan. You'll have the extra money in your pocket by the time you pay off your mortgage early. You can use a mortgage payoff calculator to see how much interest and time you'll save.
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Make a Lump Sum Payment
What are some ways to use an inheritance check, tax refund, or work bonus? You can choose to make lump sum payments to pay your home loan early. For instance, you come into a $30,000 inheritance. You decide you want to put it toward your mortgage principal of $100,000. While this won't pay off your mortgage, it can reduce your monthly payments.
With a large additional payment, you can ask your lender for a mortgage recast. What this does is restructure your monthly mortgage payment and minimum monthly payment. Let's say your monthly mortgage payments were $800 before the lump sum payment. With a mortgage recast, you now only have monthly payments of $650.
A recast lets you save money each month or make even more extra payments toward your principal. You could keep paying off your mortgage with $800 monthly payments. With this extra $150, you'll pay off your mortgage even faster.
Before you decide to put a large amount of extra money toward your mortgage, consider prepayment penalties and your financial circumstances. Maybe you need that extra cash for home improvement projects, property taxes, retirement, or an emergency fund. Interest rates for investment accounts might also produce a higher yield if you save that money instead.
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Do a Mortgage Refinance
A mortgage refinance is one way to pay off your mortgage early. However, there are several considerations to examine closely. Interest rate, closing costs, and the monthly mortgage payment are the top three. In most cases, it doesn't make sense to refinance unless you can lower your interest rate by at least a percentage point.
Lower Interest Rates
You may find a financial planner who advises half of a percentage point is worth it. But sometimes high closing costs eat up those extra savings from a lower interest rate. Let's say you can refinance to a new 30-year home loan with an interest rate of 3.50%. Your current principal balance is $240,000 on a 30-year mortgage with a 4% interest rate.
Let's say you're only a couple of years into your mortgage. In this scenario, adding another two years to your loan term and tens of thousands of dollars in closing costs will put you behind. You'd save more money by making extra payments on your mortgage loan or paying off your mortgage like it had a 15-year term.
Shorter Loan Term
Going through with a refinance under favorable conditions can help you pay off your mortgage early when you reduce the term and interest rate. Converting from a 30-year loan to a 15-year mortgage is an example. A loan balance with a shorter term carries less risk and fewer interest payments. Typically, the shorter the term, the lower the rate.
However, you'll sacrifice a lower monthly payment for a lower mortgage interest rate. On a 30-year loan, your monthly minimum might be $1,200. Under a 15-year term, that mortgage payment might be $1,700. Make sure the payment is not too much of a financial burden given your take-home income and other expenses like student loan debt.
Consider how much cash you need to pay your normal monthly expenses, including credit card debt and contributing to a savings account. You don't want to create a personal finance situation where you can't build an emergency fund or pay extra for vacations or homeowners insurance.
Remember that taxes and insurance rates tend to increase with the value of your home. If you're on a fixed income, you may want to make one extra monthly payment a year or pay off your mortgage like you have a shorter loan term. You can use an online calculator to see what your extra principal payment would be and then pay extra when you can afford it.
Choose Different Lending Services
Sometimes you can lower your mortgage payments and interest rates through a different lender. Refinancing with more favorable terms can help you make extra payments and avoid a mortgage prepayment penalty. Choosing a lender that allows early mortgage repayment without fees lets you pay off your mortgage faster.
After taking every major monthly expense into account, you can either set up a biweekly payment schedule, make an extra mortgage payment periodically, or submit additional payments each month. When researching other lenders, look at closing costs and points, interest rate, loan length, and prepayment penalties.
Does it Make Sense to Pay Off Your Mortgage Early?
Contrary to popular belief, it doesn't always make sense to pay off your mortgage early. Paying off your mortgage before its normal schedule may cost you.
If you're young and have a larger amount of mortgage debt, it may make more sense to invest your extra money. This is because interest on an investment or savings account may be higher than what you're paying on your mortgage.
In other words, you'd increase your cash flow more by investing your extra payment. Let's say a 5-year CD pays 8% interest. The rate on your mortgage is only 3.5%. By placing an extra payment of $200 a month in an investment account, you'll accumulate more during those five years than you would save by paying off your mortgage faster.
Another reason why paying off your mortgage early might not be the best idea is when you're short on other financial goals. Making an extra payment reduces your liquidity. More of your money is tied up in your home instead of an account you can withdraw from. To access your home equity, you either have to sell your home or take out another loan.
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Take the Long-Term Perspective
If you don't have money set aside for emergencies, college funds, or retirement savings, paying your mortgage earlier isn't as smart of a move. Put your extra cash toward these other financial priorities first before you go about paying off your mortgage early. You may move before you pay off your home anyway, especially if you're younger.
Once you move and sell your home, you can benefit from the equity you built up. You can use your proceeds to trade up to a larger home or downsize to trim your budget. Remember that as you age, what you need and want from a home is likely to change. You could start out in a condo or townhome but then need a single-family home to accommodate a growing family.
Likewise, you could want to downsize once the kids leave the nest. Maintenance and upkeep of a home, HOA fees, job changes, and neighborhood restructuring can all impact the usefulness of your home. Paying off a mortgage early when you're not sure if you'll be there in five or 10 years might not be the best use of your money.
However, if you're closer to retirement it may make sense to pay off your mortgage loan earlier. Say you've got a healthy IRA built up and all your money is in conservative funds that pay 3% a year. Your remaining mortgage is accumulating interest at 4%. Paying off your mortgage faster with an extra payment each month will be more advantageous.
As you near retirement, you might want to make more room in your budget. Making an extra payment to get ahead of schedule means you can retire early or save extra in your IRA towards the end of your working years. It may make more sense to put lump sum payments against your remaining mortgage and then start investing that extra money.
Not having a mortgage can give you and your children peace of mind. You know that you can remain in your home without as much burden. There will also be more equity in your home should your next of kin need to sell it or transfer ownership. Most of all, you'll no longer have to pay interest on one of your estate's largest assets.
Should I Stick to the Regular Payment Schedule?
The biggest reason to stick to your regular payments is penalties and fees. Before you do anything, ask your lender "do you charge prepayment penalties"? You should find this out before you sign a mortgage online or in person. While there's nothing wrong with choosing not to prepay a mortgage, you don't want to tack on extra fees.
Instead, you want flexibility and the highest number of choices. Without a crystal ball, you don't know what your financial situation will look like a year or 10 years from now. Maybe you don't have enough in your budget to pay extra each month today. However, what if you get a raise or need to trim your monthly expenses?
You can stick to the regular schedule for now and then adjust it as your income goes up or you come into money. Another reason why you might not want to accelerate your payments is that you have other significant debts. Other debts with higher interest should take priority.
Do you have a lot of credit cards, student loans, or auto loans? Often, these debts can carry higher interest than mortgages. The rates on credit cards can be as high as 23% or more. Any debt and monthly balances you carry on credit cards should get your attention first. You'll save more by paying these balances down before your mortgage.
Depending on your mortgage's rate, it could be more expensive to carry student loan balances. This is a debt you can't discharge with bankruptcy either. Allocating extra income to student loans can save you a headache down the road and your credit rating.
Credit cards and student loans are also considered unsecured debt. This means there isn't an asset tied to the loan that you can sell or liquidate to pay it off. A lender also can't repossess an asset to resolve the loan balance, so they'll garnish other things like your wages.
However, auto loans are secured debt since the lender can repossess the vehicle if you default. Still, you should pay off these loans before a mortgage since they might carry higher rates. In addition, the terms aren't as long and are easier to pay off early. Remember a car tends to depreciate in value, unlike a home that usually appreciates.
When deciding whether you should pay your mortgage off sooner, take stock of your lender's terms, your financial situation, and your goals. Since there are several ways you can own your home outright faster, look at the pros and cons of each. Most choices will save you interest but some will have you pay closing costs and additional fees.
While it may be feasible for you to make an extra mortgage payment, there are some cases where it doesn't make financial sense. If you're not in your forever home, need to pay off other debts, or should save, stick to your regular schedule. You’ll come out ahead.
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