You did it! You bought your first home. But as you sign the closing documents and see what your home is costing you, the euphoria of your purchase may dampen, and sticker shock settle in. It’s a bit overwhelming seeing all the interest you will be paying in black and white print. Like most people, you now ask yourself, how do I pay off my mortgage early?
We are now living in our third home. Through planning, strong credit, and good interest rates, we were able to obtain our goal of paying off our mortgage early before our oldest child graduated high school. We started with a 30-year mortgage, refinanced to a 20-year mortgage, and just a year later refinanced again to a 15-year mortgage. All that happened in the first five years after buying our house. We rounded up our payments which enabled us to pay our mortgage off a year earlier than we planned. We never touched the equity, but we have peace of mind knowing it is there if we need it.
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Can you Become Debt Free?
If you have a 30-year mortgage, like 80% of American homeowners, it may seem like you will never be debt-free. You can take some specific significant steps to pay off your mortgage early and reduce the high amount of interest you would pay over 30 years. This is even true even if you chose not to refinance to a shorter-term 20- or 15-year mortgage. Some other solutions are smaller but deliberate and painless long term and can have a big impact on your bottom line.
Make Sure You Can Pay Off Your Mortgage Quicker
The first step to paying off your mortgage quicker is to check with your mortgage company and make sure it is allowed. Some companies charge prepayment penalties or only accept extra payments at certain times. After verifying prepayment is permitted, you must let your mortgage company know that any additional amount should be put towards your mortgage principal balance and not towards interest or credited to the next month’s payment. When making an extra payment by check, write “payment for principal” in the memo line!
Big Steps to Consider
Make Biweekly Mortgage Payments
Normally, you pay your mortgage once a month, making twelve payments a year. If you make your payments biweekly (every two weeks), you will pay one extra mortgage payment a year. Look at the difference this can make for an original mortgage of $350K:
Don’t forget to include tax and insurance in your payment if it is typically included. That way, your escrow account is funded adequately, and you won’t have a shortfall. Also be sure to account for increasing real estate taxes and insurance costs over time when you plan out your payments (and buy your house).
Some lenders allow biweekly payments without any issues, while others won’t process a partial payment. Don’t pay extra fees to set up the biweekly payment process! If your lender does charge fees, instead transfer the biweekly amount to a dedicated bank account. You can set up automatic deposits to the savings account biweekly and make payments monthly towards your mortgage. Simply pay the 13th payment in late December.
Want to see how biweekly payments would impact your mortgage? Plug your information into this mortgage calculator:
Things to Consider
There are a few essential things to consider before putting extra payments towards your mortgage. Do you have higher-interest loans such as credit cards? If so, you should pay that debt off before you making additional mortgage payments.
Is your emergency fund adequately funded? Most experts recommend your emergency fund have a minimum of 3 to 6 months of expenses. If your job is insecure in volatile times, you may want to save 6 to 12 months of expenses before investing in a home. It would be terrible to have your homeownership plans derailed by not having a cushion in unexpected hard times. Not sure where to start with repaying existing debt and building your emergency fund? Following a planned budget, like the 50/30/20 Budget Rule can help.
Refinance to a Shorter – Term Mortgage
Shorter-term mortgages traditionally have higher monthly payments but lower interest rates. Does it make sense to refinance your mortgage? The shorter length of a 15- or 20-year mortgage means less interest. Rates are slowly creeping up from where they were last year, but there are still reasonable rates available.
If we take a mortgage of $350k and plug it into a mortgage rate calculator (leaving out taxes and insurance for simplicity), we get the following results:
The interest rates above are the average rates in March 2021. Interest rates will vary according to lenders, credit history, amount of down payment, home value, and even where the home is located.
Downsize to a Smaller Home
If your goal is to pay down your mortgage and it’s simply not affordable, it may be time to sell your more expensive home and buy a more affordable one with the proceeds from the sale of the original house. Even if you can’t pay cash for the new home, you will have reduced your mortgage. An even better step is to make sure you can afford the house you buy in the first place. It’s easy to get swept up in the excitement of purchasing a home and not look at all the costs, including taxes, utilities, and insurance, that you will incur. A Smart Budget can help make sure you take into account all your expenses. It’s not just for those nearing retirement!
Increase Your Down Payment – The amount of money you put down for your down payment will affect your interest rate. A 20% down payment will generally qualify you for a lower rate. Most lenders will require a PMI (private mortgage insurance) payment if less than a 20% deposit is paid. The PMI is included in your monthly mortgage payment and costs 0.5% or 1% additional until enough of the principal had been paid down. PMI is then removed from the mortgage.
Small Steps to Take
Stop Buying Coffee Out
According to MSN, the average American spends about $90 per month on takeout coffee. Bring your coffee from home and add that $90 to your mortgage payment, earmarked for the mortgage principal. That is an extra $1080 a year that can go towards reducing your mortgage. Don’t forget when you pay down the principal; you are also reducing your interest. If you round it up to $100, you can take almost three years off your mortgage and save $22,661.89!
Bring Your Lunch to Work
Along the same lines as coffee, bringing your lunch to work can save you big bucks. The average worker spends $100 on lunches monthly. Apply that $100 a month towards your mortgage, and you’ll save big on your interest. Add that $1200 to your coffee savings, and you can pay an extra $2280 a year on average. That is more than the additional mortgage payment a year in our example.
Not ready to make a significant change on takeout habits? Try rounding up your mortgage payment automatically. You might not notice paying $1600 a month instead of $1536.70. You will see the dent the extra $760 will make in your principal and lessen the interest you will pay over time.
Final Thoughts on How to Pay Your Mortgage Off Early
One nice thing about using a bimonthly payment system or increasing your mortgage principal payment with a 30-year mortgage is you are not tied in to a more expensive payment like you are with a 20- or 15-year mortgage. This allows flexibility in case of unexpected hardships or expenses. Hopefully, you would pay your original payment and avoid penalties that may occur with the required higher payment.
My husband and I took deliberate steps to pay off our mortgage before our kids entered college because we didn’t want to pay college costs and a mortgage. It was both the big (refinancing) and small steps (rounding up payments) that made it possible to pay it off a year before our eldest went off to school. We were surprised when the deed showed up in the mail! The extra principal payment was automatic, so we didn’t even notice it. Also in our favor is our student loans were paid off, which made extra money in our budget available. With a plan, you can achieve this goal too.
Mortgage Calculator: https://www.calculator.net/mortgage-payoff-calculator.html
General Information About Mortgages: https://www.usa.gov/mortgages
Looking For the Best Mortgage: https://www.hud.gov/sites/documents/BOOKLET.PDF
Understanding Loan Options: https://www.consumerfinance.gov/owning-a-home/loan-options/
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Christine Seaver is a freelance writer that writes about personal finance, budgeting, and debt. She is a frequent contributor at Dividendpower.org. Christine works as an office manager by day and a cookie baker at night. She lives in Massachusetts with her family.