That 30-year mortgage sounded great at the time, right?
Now you're looking into the future and thinking about how old you'll be in 30 years. Do you really want to be paying off the same mortgage until then?
That idea is the same reason so many Americans start looking for ways to pay their mortgage early. Before you get too discouraged, realize paying off your mortgage faster is doable. In fact, 19.9% of all housing units in the US are occupied by an owner who's mortgage-free.
If you want to join that 19.9%, you've come to the right place. There are plenty of strategies available that depend on your budget, interest rate, and other circumstances. Try these strategies on for size:
1. Refinance to a Shorter-Term Mortgage
Refinancing your mortgage is often the most effective way to pay off your mortgage early. It does, however, require more effort and more commitment than the other options below.
In a way, when you refinance your mortgage, you're paying off your existing mortgage with a new one. Many homeowners choose to refinance from a 30-year loan to a 20, 15 or 10-year fixed rate loan.
Advantages to Refinancing with a Shorter-Term Mortgage
The largest reason homeowners refinance is the interest rate. Shorter loans almost always have lower interest rates than longer term loans. Over the life of your mortgage, this can add up to hundreds of thousands of dollars.
In addition, a shorter loan term tends to require you to pay a higher monthly payment. This forces you to pay off your mortgage sooner. Refinancing is also a way to change other aspects of your loan, like switching between an adjustable rate mortgage vs. fixed rate mortgage.
If you have a 30-year mortgage and you're looking for a shorter term, a 15-year mortgage is the most common option. However, some lenders also offer 18-year and/or 20-year mortgages, while others offer a 'pick a term' that will allow you to choose the length, in years, that is the best fit for you and your budget.
How Your Interest Rate Affects Refinancing
The key to benefiting from refinancing is your interest rate. Let's say you bought your house when you were 25, and like most people in their 20s, your credit and down payment were not stellar. You found yourself with an 8% interest rate on a 30-year mortgage.
Now it's ten years later, and you've built strong credit in those ten years and your house has appreciated in value. You may be able to refinance to a 15-year loan with a 3% interest rate. That's a massive drop in your interest rate.
In the scenario above, you had 20 years of payments left before you refinanced. By switching to a 15-year mortgage, you're taking five years off your payoff time and keeping your monthly payment relatively the same.
Disadvantages to Refinancing Your Mortgage
Of course, no one's handing out free money. There are hurdles to overcome if you want to refinance.
First, there's work involved. You're basically getting a new loan altogether, so you need to go through the application process.
Second, you'll pay closing costs, similar to the costs you paid when you were buying your home. Depending on the size of your mortgage, these costs can be substantial.
Another potential problem is that you're committing to a larger monthly payment. For homeowners who struggle with self-discipline, this could be good. For others, though, you have less flexibility in case you fall on hard times in the future.
Keep in mind that there are rare occasions in which you can refinance into a shorter loan without a higher payment. This could be the case if you get an extreme drop in your interest rate. The lower interest costs could make up for the fact that you're shortening the loan length. However, these cases are rare so you shouldn't bank on it.
When it Makes Sense to Refinance
While refinancing can be a great choice for some, it doesn't make sense for all situations. The key is knowing whether your circumstances would benefit from refinancing.
Refinancing isn't ideal for people who plan to sell their home soon. If you aren't planning to stay in the home for more than a few years, your lowered interest fees may not make up for the closing costs.
On the other hand, refinancing is a great choice for people who have a high interest rate. In addition, the higher your credit score is, the more likely it is that you'll benefit from refinancing.
You should also remember that while you would love a shorter loan payoff, you need the income to make a higher payment. If finances are tight, refinancing to a shorter loan term might not be feasible.
2. Make an Extra Mortgage Payment Every Year
Some homeowners pay off their mortgage faster by making 13 payments each year instead of 12. There are a few ways to do this.
One option is to schedule your monthly payment every four weeks rather than every month. Over the course of a year, this adds up to a full extra payment. This isn't something you need to arrange with your bank; you just change your own bill payment schedule.
Another option is to choose a time of the year to make an additional payment. If you get a large year-end bonus, for instance, you could use it to make an extra mortgage payment.
Advantages of Making an Extra Mortgage Payment
The obvious advantage to making an extra payment each year is that you pay off the mortgage loan sooner while retaining flexibility.
One extra payment per year might not seem like much. However, it takes off more than you might think. Let's say you have a $200,000 mortgage at 4% interest with a $955 payment for 30 years. If you start making an extra payment each year, you could pay it off in less than 26 years. Four years or 48 payments of $955 equals $45,840 in savings.
One of the key advantages to this method is the flexibility. If you fall on hard times, you can go back to a monthly payment schedule without your annual extra payment.
For some homeowners, four-week payments are also easier to coordinate with their cash flow. If you get paid every two weeks for instance, you can make sure your mortgage payments always coincide with a recent payday.
Disadvantages of Making an Extra Mortgage Payment
On the flip side, four-week payments can be a burden for people who get paid monthly or bimonthly. If they don't line up with your pay schedule, you may need to pull a temporary payment from your savings account to keep up with your schedule. Make sure you put the payment back in when you get your next paycheck, though.
We also mentioned that you can make an extra payment once per year instead of making payments more often. The downside with this is that you don't get the benefit of paying less interest as the year goes on. If you wait to pay off extra principle until the end of the year, you've been paying interest on that principle all year. The key is to start paying extra as soon as possible and as much as is affordable to your budget.
Another possible downfall to this method is that it requires discipline. It's easy to say, "Let's skip the extra payment just this once." If that isn't necessary for your financial stability, you end up with the same payoff date you always had.
3. Set Up Bi-Weekly Mortgage Payments
We've already talked about making your payments more frequently but there's another option for this as well. You could break each monthly mortgage payment into two bi-weekly payments.
This tends to work well for people who get paid every two weeks. If you set up an automatic bill payment for the day of or the day after each paycheck. The money comes out of your account and you never have to think about it.
Advantages to Bi-Weekly Mortgage Payments
You might think, "If I'm paying the same amount each month, how does it save me money?" There are a few distinct advantages.
First, you'll end up paying a full extra payment each year. With 52 weeks each year, you're paying 26 half-payments, which adds up to 13 total payments throughout the year.
Second, you may save on interest charges. This depends on how your interest is calculated. It may seem like a small difference, but it adds up to big savings over the life of your loan.
For some homeowners, the psychology of bi-weekly payments is easier to handle as well. If you feel anxiety when you make that one large payment each month, smaller payments can be more palatable.
Unlike refinancing, this option also lets you retain your financial flexibility. You're paying off the loan on a faster basis, but if money becomes tight at some point, you can scale back to a monthly payment schedule.
Disadvantages to Bi-Weekly Mortgage Payments
For all its benefits, bi-weekly mortgage payments can have their drawbacks. For some homeowners, it doesn't mesh well with their payday schedule. In that case, it can be difficult to maintain your cash flow in a steady, organized way.
Another important factor is that you need to make sure you can afford the boost. Some homeowners put more money into their mortgage but they make up for it by putting more of their ancillary purchases on a credit card. In other cases, they may fall behind on other bills and incur penalty fees that counteract the mortgage savings.
4. Round Up On Your Monthly Payments
An easy way to put more money into your mortgage without feeling the pain in your finances is to round up. For instance, let's take the $955 mortgage payment from our earlier example. Round it up to the nearest hundred so you pay $1000 per month instead.
If you start doing this from the beginning, your mortgage payment is $1000 in your mind. You don't even notice that you're paying more than you need to until you wind up paying off your mortgage earlier.
Advantages to Rounding Up Your Mortgage Payments
Whether your interest compounds monthly or more often, this method will save you money in the long run. The less principle your loan has when the interest compounds, the less interest you'll pay. When you make every monthly payment larger, you'll get that benefit every month.
For many homeowners, rounding up also has little effect on their budget. You don't miss the money because it feels like a small amount, but it adds up over the life of your loan.
Let's look at the example of the $955 payment on a 30-year mortgage. By rounding up to $1000 per month, you'll take almost 2.5 years off your payoff date.
Another helpful feature to this method is that you retain more flexibility. If an unexpected expense comes up or your income changes, you can reduce your mortgage payment to its original amount. You're still meeting your obligation to the lender while making more room in your budget.
Disadvantages to Rounding Up Your Mortgage Payments
The flip side of financial flexibility is the need for financial discipline. As with the extra annual payments, it's easy to stop rounding up and spend the money on something less responsible instead, like a late a day.
It's also important to make sure that this doesn't put a strain on other bills. Some homeowners increase their mortgage payments but they do that by putting more purchases onto their credit card than they otherwise would. If you're paying an extra $100 per month toward your 4% mortgage while adding $100 per month to your credit card with 20% interest, you're doing more harm than good.
The Key to Paying Off Your Mortgage Faster
Everyone wants to live debt-free, but it's just one of many financial goals. The key is balancing paying off your mortgage with saving for retirement, paying off higher-interest debts, and other long-term goals.
At the end of the day, it's all about finding the strategy that works for you. Some homeowners even use a combination of the tactics above. They refinance to a shorter term with a lower interest rate and make those new payments in bi-weekly installments, for instance.
If you're re-thinking your mortgage or if you have further questions about your mortgage payoff, reach out to our Seattle mortgage lender experts.