Pay Off a Mortgage Early
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Mortgage-free living cultivates financial freedom on several levels. You could cut your term from 30 to 15 years, or you could rid yourself of the loan entirely. Having shared this, there are also times when the move to pay off a mortgage early isn’t your best option.
I. Before You Go Forward
IV. How to Pay Off Early
V. Payoff and Retirement
VI. Final Questions to Ask
VII. Bottom Line
I. Before You Go Forward
When you pay off a mortgage early, your life changes dramatically. For starters, you own a central asset of significant value outright. Second, you save a considerable amount of money on interest expenses, which can be shifted to any number of good uses. But there are other considerations. You may be able to earn more after-tax income in other investments than what you would save in interest through the decision to pay off a mortgage early. This would depend on several factors — how many years you have left on your mortgage, your current interest rate, your discipline in saving, and your ability to invest wisely.
Below are seven ways the move to pay off a mortgage early would be beneficial.
Save on interest payments
When you reduce your loan term, you agree to make a larger monthly mortgage payment today in order to save thousands, even tens and hundreds of thousands in interest over the life of the loan.
Guaranteed return on investment
The money you save in interest is a definite quantity based on your interest rate. Because you pay a significant portion of the interest on a 30-year mortgage within the first 10 years, you’ll have the potential to save much more if you’re within the first decade of your mortgage versus the last 10 years.
Increase monthly cashflow
If you plan on retiring or cutting back your work hours while staying in your home, you can keep more of your fixed-income cashflow. When you pay off a mortgage early, you get rid of perhaps your largest monthly payment.
Drop private mortgage insurance (PMI)
The quicker you pay down the principal on a conventional loan, the quicker you’ll meet the minimum loan-to-value (LTV) threshold needed to request to drop PMI.
Gain peace of mind
Some wins aren’t financial in nature. If you’ve ever struggled to afford your mortgage payment, then you felt the stress that came with the threat of losing your home. When you pay off a mortgage early, the opposite dynamic becomes reality — you gain the financial flexibility to pursue other investment options, career changes, or leisure activities such as traveling.
Increase your equity at a faster rate
More equity gives you more leverage on a home equity loan or home equity line of credit (HELOC). These financial tools allow you to pursue another investment opportunity, renovate your home, or cover an emergency.
If you know you’ll spend the money elsewhere, the choice to pay off a mortgage early can be a forced savings plan and put you on a quicker, surer path to owning your home mortgage-free.
There are also 8 opportunity costs when you commit to eliminating a mortgage.
Fail to capitalize on other investments
You might be able to earn considerably more with your extra lump sum cash or monthly cashflow than what you could save in interest. Explore investing options, with a focus on tax-free environments and stable returns. Consider compounding, which is when interest can itself earn interest. The sooner you can get your money amplifying, the better. But exercise caution. With investing comes the element of risk. Weigh the potential for losses against the guaranteed benefit of accelerating a mortgage payoff. Balance the considerations as you weigh the option to pay off a mortgage early.
Be less liquid
The equity you build in your home isn’t considered liquid. That means significant money is tied up in your home and you can’t immediately withdraw it unless you sell your home, pursue a cash-out refi, or choose either a home equity loan (HELOAN) or home equity line of credit (HELOC).
Pay a prepayment penalty
Contact your lender to inquire. If there are prepayment penalties, then they likely are only assessed within the first three years of the mortgage. It’s generally capped at 2% the first two years and 1% in subsequent years.
Allow higher interest debt to persist
As you look to pay off a mortgage early, don’t lose sight of other debt you’re carrying. For example, credit card debt could have a higher interest rate attached. Consider the credit score implications of keeping lines open versus closing them. It may be that addressing one or more charge cards provides a substantial lift to your credit rating. Armed with this enhanced asset, you could very well secure a better rate for a refinance.
Endure greater duress in emergencies
With more of your money committed elsewhere, you could be less prepared for unfortunate circumstances that arise. Examples include accidents and other pressing health challenges, items that break and require repair, sudden loss of income, and more.
A mortgage may provide the motivation to continue working, which can be viewed as a positive or negative depending on the situation and your mindset. The decision to pay off a mortgage early can be undeniably liberating.
IV. How to Pay Off Early
Here are five options to weigh and execute as you pay off a mortgage early:
- Refinance into a shorter-term mortgage. With record increases in home appreciation across many parts of the country, now may be the prime time to refinance into a shorter term. Remember to factor in closing costs. Your monthly payment may be higher, since you’re decreasing the timeframe for paying off the loan.
- Switch to bi-weekly payments. Consider paying your mortgage every two weeks versus monthly vs. once a month. You’ll pay half the monthly amount every two weeks, which equates to 26 half payments or 13 full payments. That means one extra payment a year, which reduces the life of your monthly mortgage payments and helps you pay off a mortgage early. Consult with your lender or mortgage servicer to make sure they’ll accept bi-weekly payments.
- Make larger payments toward your principal. Add a few hundred dollars to your monthly mortgage payment to address more of your remaining loan principal. Explore whether you can shave a year or more off the life of your mortgage. One method is to take your monthly payment and divide it by 12, then pay that much extra each month. See how much you can save by asking one of our loan officers to produce a a more nuanced scenario top pay off a mortgage early by months or years.
- Contribute a lump sum principal payment towards loan principal while recasting your mortgage. With a lump sum payment toward your principal, you may also become eligible to recast your mortgage. Your lender would then recalculate your amortization schedule (which is the amount applied to interest and principal each month) to reflect a new balance. You’ll have a lower payment, but your interest and term will remain the same. The fees for a recast are often much lower than a refinance. If your interest rate is low, then this may be a viable option. Unfortunately, a recast isn’t available with VA and FHA loans.
- Explore house-hacking. Convert space in your home to an accessory apartment. Apply for a certificate of occupancy. Rent at market rate and add this to your normal payment, which would place you on a quicker path to pay off a mortgage early.
V. Payoff and Retirement
The sooner you pivot to pay off a mortgage early, the more you save on interest. On a 30-year mortgage, you could pay a large amount of the total interest during the first 10 years of the loan. That’s because lenders follow a mortgage-style amortization schedule which keeps your monthly payment the same for the life of the loan. But that also means more of your total monthly payment applies to interest instead of loan principal for part of the loan term.
The same is true when it comes to retirement contributions. The earlier you start, the more you accrue with compounding interest. It’s a tough decision to make: to pay off a mortgage early or invest toward retirement. If you’re disciplined enough to make consistent investments to both areas, then that’s often the best route to take.
VI. Final Questions to Ask
- Do you have money left over each month after expenses? Do you have a lump sum of cash or retirement savings?
- Will you pay off a mortgage early with a windfall of cash or make additional monthly payments toward principal?
- What’s your interest rate? Is your interest compounded annually or monthly?
- Do you have other high-interest debt (credit cards, personal loans, student loans)? Are you better off paying any or all of those down first?
- Do you have a 15-year or 30-year mortgage? How many years left do you have on your mortgage?
- If you don’t use the funds to pay off a mortgage early, where will you use your money? What are the opportunity costs? Can you make more money elsewhere?
- What is the peace of mind of not having a mortgage worth to you? Are you close to retirement?
- Will all your cash savings be tied up by paying down a mortgage? Do you have an emergency fund?
- Does your mortgage have any prepayment penalties?
- What’s your personal risk tolerance?
- What if home prices suddenly fall and you need to sell quickly?
- Have you created a financial roadmap? Does it align with your personal goals? If you have a significant other, then is your partner on board with the plan? Have you weighed your options and prioritized your budget? What do you plan on doing with your money if you commit to pay off a mortgage early?
VI. Bottom Line
Paying down your mortgage is a great way to ensure you save money. Using your extra money to invest can also be a good tactic, but you need financial discipline. You have to set aside money. You must then make the right investments that beat what you would otherwise save in interest payments through mortgage payoff.
Sometimes, the peace of mind that comes with being mortgage-free is worth more than the bottom line. Unfortunately, many squander their savings on expenditures that are more short-term in nature and don’t align with long-term goals. They won’t pay off a mortgage early or invest wisely. As a result, they pay interest longer than they should.
Refinancing can be a great way to shorten your loan term, get cash out on your home equity, or achieve a lower mortgage payment. Whichever path you take, explore at least some preliminary planning. Stay focused on what matters most to you.
Begin your journey to greater financial freedom today. Connect with a loan officer below to explore a personalized mortgage plan and other options. The service is free of charge and obligation.
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