Laura answers a listener's question about paying off their mortgage ahead of schedule. You’ll learn seven ways to get rid of your home loan as quickly as possible and if it’s a smart financial move for you.
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After signing a mountain of paperwork and becoming a proud homeowner, you might be eager to pay off your mortgage early. Owning a home free and clear is terrific, but it may not always be the best use of your money.
In this show, you’ll learn who should and shouldn’t pay off their mortgage ahead of schedule. Plus, seven ways to become mortgage-free if it’s a smart financial move for you.
Hi, everyone! My name is Laura Adams, and I want to thank you for tuning in this week. I'm an award-winning personal finance author and have hosted the Money Girl podcast since 2008. I also partner with select brands for PR and marketing work as an on-camera spokesperson, consumer advocate, voice-over talent, and multimedia creator.
Here on Money Girl, my mission is to help you get the knowledge and motivation to prioritize your finances, build wealth, and have more security and less stress. Every episode is a mini-money training designed to help you take your financial life to the next level.
The topics I cover might come from a listener's question, what’s going on in the financial news, or an interview with a subject-matter expert guest. So, if you like what you’re hearing, be sure to subscribe, so you automatically get each weekly episode.
And thank you if you're already a long-time listener! If you're enjoying the show or have a personal finance or small business question, you can leave a message 24/7 at 302-364-0308. You're also free to shoot me an email using my contact page at LauraDAdams.com.
Today's episode is number 738, called 7 Strategies for Paying Off Your Mortgage Early.
I’m going to answer a question from JaTori R., who asked, “How does paying an extra $100 per month versus 13 full monthly payments per year affect the term of your mortgage?”
Thanks so much for your question, JaTori! As I mentioned, paying off your mortgage early isn’t the right move for everyone. A critical concept to take away from this show is that mortgages are way down on the list when it comes to prioritizing debt. And I know that may seem counterintuitive because a mortgage is an enormous debt.
So, I’ll start by explaining the advantages and disadvantages of paying extra on your home loan. The downsides may surprise you–so be sure to stay with me if you have a mortgage or want to become a homeowner one day! Then I’ll review seven strategies to pay off your mortgage faster–if that’s right for you.
The primary advantage of paying off a mortgage (or any debt) ahead of schedule is paying less interest. For example, if you owe $150,000 on a 30-year, fixed-rate mortgage at 5%, your monthly payment is about $800.
If you keep the home for 30 years, you’ll pay $140,000 in interest. Yes, that almost doubles the actual cost of the property!
But if you get a $20,000 windfall and use it to pay down your mortgage in the fourth year, you’ll pay off the loan in 23 years instead of 30. That cuts your total interest from $140,000 to $98,000, which saves you $42,000. Not bad, right?
But the disadvantages of paying off a mortgage early are apparent when you compare it to other options. It’s important to remember that a mortgage is a relatively inexpensive debt that comes with tax benefits, making it cost even less. Right now, the going rate for a 30-year, fixed-rate mortgage is just over 6%
Once you send extra money to a mortgage, it's tied up in your property. If you unexpectedly lose your job or suddenly have a significant expense, you won't be able to get that money back quickly, if at all.
Additionally, you may lose the opportunity to invest your extra money for higher returns than your after-tax mortgage interest rate. For instance, investing in a mutual fund in a Roth IRA that pays 8% on average is better than paying down a mortgage that only costs you 5% after taxes.
While getting rid of any debt is ultimately good for your finances, paying it off in the correct order is essential. Always consider your mortgage in the context of your entire financial situation.
My first question for JaTori is, do you have an emergency fund? The second is how much are you saving for retirement?
If you don’t have a healthy emergency fund, you aren’t investing at least 10% of your gross income for retirement, or you have high-interest debt (such as credit cards), it’s never wise to send extra money to your mortgage.
Living mortgage-free may sound good, but the bottom line is that it’s not always the best use of your money. You’re much better off saving for emergencies, getting rid of expensive debt, and shoring up your retirement before paying off your home ahead of schedule.
But if JaTori has emergency savings equal to at least three months’ worth of living expenses, invests 10% to 15% for retirement, and has no other debt, chipping away at the mortgage is an excellent financial move.
So, how do you do it? The key to paying off a mortgage (or any debt) early is simple: send more money that gets applied to the principal balance. Note that with a fixed-rate mortgage, a portion of each payment goes toward your principal balance and the interest.
In the early years of a fixed-rate mortgage, the payment amount credited to your principal is small, and the interest is large. But that shifts over time and is eventually reversed. By the end of a fixed-rate mortgage, most of your payment gets credited to the principal, and you pay little interest.
That payment schedule is known as amortization. It happens because as your principal balance decreases, so does the interest you must pay–but your monthly payment stays the same. The excess gets subtracted from your principal every month, helping you build equity in your home over time.
If paying off a mortgage early is wise for your situation, there are various strategies you can use. Some are easy on your pocketbook but take more time, while others may be more challenging for your finances but reduce your balance faster.
Let’s review seven strategies to pay off your mortgage early.
Strategy number one is to make bi-weekly payments.
Some mortgages offer an accelerated, biweekly payment schedule, which is a great strategy. Biweekly payments allow you to take advantage of the fact that there are 13 weeks in each quarter, not 12, and 52 weeks in a year, not 48.
You make a whole additional payment yearly by paying half of your mortgage payment every other week (instead of one monthly payment). That schedule works exceptionally well if you get paid every other week, so the biweekly loan payments occur close to your paydays.
Suppose you have a 30-year mortgage for $160,000 at 6.5% interest. The payment is $1,000 per month or $12,000 per year. If you keep that payment schedule, you'll pay about $202,000 in interest over the life of the loan.
But if you make biweekly payments instead, you’d pay half the monthly payment, or $500, every other week. You’d pay $13,000 in interest per year instead of $12,000.
Sticking to that biweekly schedule would cut your interest from about $202,000 to $184,000, saving $18,000 over the entire loan. You'd also pay off the loan in over 27 years instead of 30. Brilliant!
The problem is that some lenders may not offer a biweekly payment schedule because they don't want to give up interest income or deal with the administrative hassle. So, instead of applying your early payments to your principal balance, they could put it in escrow and hold it until they receive your full payment. If that's the case, making biweekly payments won't help you.
So check with your lender about the best way to make biweekly payments. If they try to make it complicated or charge a fee, I recommend using another payoff strategy I'll cover.
Strategy number two is to make an extra payment each year.
If you can’t get a mortgage lender to apply biweekly payments to your principal as you send them, make one extra payment a year that gets fully applied to your balance.
Let's say your monthly mortgage payment is $1,200. Make a goal to save that much by putting $100 per month in dedicated savings. At the end of the year, you've got an extra payment to send to your lender.
Make it clear that you want the entire amount applied to your balance by entering "apply to principal" in the memo section of your paper check or online payment. Or you could make the payment through an online account with your lender, where it may be easier to indicate that you want the extra amount to get applied to your principal balance.
Strategy number three is to add an extra amount each month.
If you’re determined to pay down your mortgage early, every little bit will help. Instead of saving to make an additional large payment once a year, pay an extra amount each month.
Let’s say you have a $100,000, 30-year, fixed-rate mortgage at 4.5%. If you add an extra $100 to your monthly payment, you’d pay it off almost nine years earlier and save over $26,000 in interest.
That's likely what JaTori is asking. Knowing how paying an extra $100 per month compares to making an additional mortgage payment once per year depends on your mortgage interest and monthly payment.
Using the How Long to Repay My Mortgage Calculator is an excellent way to compare how much you'd save in different scenarios. Plugging in your mortgage details and extra payments allows you to know which option saves you the most money.
Strategy number four is to apply your windfalls.
While you can pay off your mortgage slowly and steadily by regularly paying the same amount each month, you don't have to be consistent. There's nothing wrong with sending one big payment when you can.
If you get a bonus at work, a tax refund, or an inheritance, put all of it toward your mortgage and then return to making regular payments. You won't even miss the money.
Strategy number five is to round up your payments.
If you don't have much extra money to pay off your mortgage early, you could round up your monthly payments. For instance, if your payment is $970, why not just pay $1,000? Again, be sure to indicate that the extra should go toward paying down your principal balance.
Strategy number six is to set a target payoff date.
If you have a specific date in mind that you want to be mortgage free—such as on your 50th birthday, when your kids are finally out of the house, or when you retire—figure out how much extra it will take.
Since the math is complicated, use an online mortgage calculator to help crunch the numbers. Enter different amounts of extra payments until the final payoff date is close to your target.
Strategy number seven is to get rid of PMI.
PMI or private mortgage insurance is charged by lenders when you take out a conventional home loan and pay less than 20% down. However, after you pay down your mortgage to 80% of the original value, you can request a PMI cancellation.
If you have a 30-year fixed-rate loan for $180,000, the PMI could be close to $100 per month. Getting rid of that premium frees up $100 to send to your mortgage principal instead.
To sum up, I want to reiterate that if you don’t have rock solid finances with plenty of emergency savings, regular retirement contributions, and no debt besides your mortgage, you shouldn’t use any of these strategies to pay off your mortgage. Instead, shore up your finances and pay off your highest-interest debts first.
Thanks again to JaTori! I hope this show points you in the right direction to handle your mortgage the right way for you.
Before we go, I want to invite you to connect with me on Twitter @lauraadams or Instagram @lauradadams. And LauraDAdams.com is my personal site where you can use my contact page and learn more about my work, books, and money courses.
That's all for now. I'll talk to you next week. Until then, here's to living a richer life.