October 14th, 2019 8:34 AM by Jackie A. Graves
Should You Pay Your Mortgage Off Early?
Paying extra on your mortgage can be a good idea. It can
cut 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, like refinancing,
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
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.
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. 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 necessary.
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. Generally, the
faster you pay your mortgage, the more money you will save.
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.
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.
Mortgage service companies say they can help you pay off your
mortgage faster. 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 run. 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 fees.
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
That’s the kind of help you don’t need.
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 increase. You’d also have to pay some
loan closing costs, although most usually can be wrapped into your loan. 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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