September 9th, 2018 11:37 AM by Jackie A. Graves, President
Paying extra on your mortgage
can be a good idea.
It can shave years off your
home loan and save tens of thousands of dollars in interest charges.
The one thing you should not
do, however, is sign up for an accelerated payment plan from a mortgage
service company that costs hundreds of dollars.
There are better ways to cut
that home loan down to size.
Here are three free and easy
options, and one that isn't free but can still save you tons of money.
The additional money you're
sending reduces the balance of your principal, which is the actual amount you
owe on the house without interest.
The biggest share of your
early mortgage payments goes to paying interest, so paying a little extra on
principal now makes a huge difference in the years ahead.
This works especially well if
you get an annual bonus or always receive a sizable income tax refund. Just add
the money to your next monthly payment.
Once again, you're chopping
away at that principal ahead of schedule.
3. Pay half of your regular monthly payment every
Although a few lenders allow
customers to switch to biweekly payments at no charge, most won't do that, nor
will they accept partial payments.
But you can have the money
automatically transferred from your checking account to a savings account every
two weeks and then transferred to your lender at the end of every month. Ask
your bank or credit union for help setting up online transactions, if
By the end of the year,
you'll have made 26 half payments, which adds up to 13 full payments — or,
again, one full extra payment.
Caution: Paying down the principal on your
home loan more quickly will never reduce the minimum monthly payment or allow
you to skip a payment.
It simply shortens the length
of the loan and reduces the total amount of interest you have to pay.
Additional monthly payment
A $200,000 30-year home loan
with an interest rate of 5% would cost $186,512 in interest with the
traditional 12 payments a year. Make the equivalent of 13 monthly payments
every year, and the loan will be retired in 26 years and you will pay only
$153,813 in interest — a savings of $32,699.
Of course, you don't have to
keep your home loan for decades to benefit from extra payments.
You'll immediately begin
adding to your equity (the difference between what your home is worth and how
much you owe on your loan). That lets you ditch private mortgage insurance sooner, saving you as much as a
couple hundred dollars a month.
If you ever have an
emergency, you'll have more equity to take out a home equity loan. And, of
course, the less you owe on your mortgage, the more money you pocket if you
sell your home.
Our accelerated mortgage payoff calculator can figure out how
quickly you can pay off your home loan and how much you'll save.
The biggest challenge to
following through with a faster payoff plan is maintaining self-discipline.
It's easy to start paying extra — until you have extra expenses or you forget
an extra payment.
That's where mortgage service
companies say they can help. When you buy an accelerated biweekly payment plan
from one, you're essentially asking the company to make you pay off your loan early.
They collect your biweekly
checks and fine you if you miss one of your voluntary payments.
According to them, the threat
of those penalties and the hundreds of dollars they charge in setup and
maintenance fees are worth it to save tens of thousands of dollars in the long
But they're not.
Start-up fees begin at $300,
and many service companies also charge processing fees of anywhere from $2.50
to $10, plus monthly or annual maintenance fees.
Some service companies pay
interest on the money they're holding, but that won't come close to covering
The U.S. Consumer Financial
Protection Bureau sued one company, Ohio-based Nationwide Biweekly
Administration, in 2015, accusing it of misleading consumers about the
potential savings from its plans.
Nationwide was charging a
start-up fee of $995, plus yearly administrative costs of up to $101.
The protection bureau noted
that someone who signed up for the plan with a 30-year mortgage of $160,000 at
4.5% would have to stay in the program for nine
years to recoup their fees. (Nationwide suspended operations after
the suit was filed.)
Even if you only pay a $300
initial fee and then $10 a month, you'll spend $420 in the first year and
$2,700 over 20 years. If you don't make all 26 payments a year on time, you'll
have late fees added to that and wind up paying even more.
That's the kind of help you
This brings us to the option
that isn't free but can potentially save the most money. If you really want to
discipline yourself to pay off your home loan sooner, consider refinancing for
a shorter time period.
Most fixed-rate mortgages are
30 years, but you can get loans that last 20, 15 or even just 10 years.
Loans that run for shorter
periods generally come with lower interest rates. The combination of a lower rate and
less time can really add up.
Let's look at that $200,000
mortgage again, this time for only 15 years. A 15-year loan runs about one
percentage point cheaper than a 30-year loan. With a 15-year mortgage at 4%,
you'd pay about $66,288 in interest over the life of the loan.
That's a savings of more than
$120,000 in interest over a 30-year loan at 5%.
Of course, your monthly
principal and interest payments would go up significantly, from around $1,074
to $1,479, so you would need to make absolutely sure you could handle that
You'd also have to pay some
loan closing costs, although most usually can be wrapped into your loan.
But if you're positive you
can swing it, shortening the time of your mortgage can be the shortcut to huge
savings — even the day you own your home free and clear.
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