It might be simple to pay off your mortgage earlier if you can afford it. But should you?
That’s a complicated question. Homeowners with low mortgage rates may be better off putting extra money in a Roth IRA or 401(k), both of which might offer a higher return than paying off the mortgage. Then there’s the college aid factor. If you’re applying for need-based aid for your kids, that home equity could count against you with some colleges because some institutions view equity as money in the bank. If, after those caveats, you want to pay off your mortgage early, Bankrate offers four ways to make that happen.
1. Refinance with a shorter-term mortgage
You can pay off the mortgage in another 15 years by refinancing into a 15-year mortgage. For example, if you have a 30-year fixed-rate mortgage for $200,000 at 4.5 percent. Then, five years later, you can refinance into a 15-year loan at 4 percent. Doing so pays off the mortgage 10 years earlier and saves more than $60,000 (if you exclude closing costs on the refi). Those shorter-term mortgages often carry interest rates a quarter of a percentage point to three-quarters of a percentage point lower than their 30-year counterparts. Refinancing isn’t quick or free. It requires filling out the application, providing documentation and having an appraiser visit. There are closing costs. And even with a lower interest rate, that quicker payoff means higher monthly payments. And this method is a lot less flexible. If you decide that you don’t have the extra money one month to put toward the mortgage, you’re locked in anyway. Unless the new interest rate is lower than the old rate, there’s no point in refinancing. Without a lower rate, you’ll get all the same benefits (and none of the extra costs) by just increasing your payment a sufficient amount.
2. Pay a little more each month
Divide your monthly principal and interest by 12 and add that amount to your monthly payment for a year. As a result, you’ll make the equivalent of 13 payments in 12 months. Let’s say you have a $200,000 mortgage at 4.5 percent. After five years of making the minimum payments, you add an extra 1/12 of a month’s principal and interest to each monthly payment. Doing so pays off the mortgage three years and three months earlier and saves more than $18,000 interest. Before you make anything beyond the regular payment, call your mortgage servicer and find out exactly what you need to do so that your extra payments will be correctly applied to your loan. Let them know you want to pay more aggressively and ask the best ways to do that. Some services may require a note with the extra money or directions on the notation line of the check. In any case, if you’re putting extra money toward your loan, always check the next statement to make sure it’s been properly applied.
3. Make an extra mortgage payment every year
Instead of paying a little more each month, make one extra monthly payment each year. One way to do this is to save 1/12 of a payment every month, and then make an extra payment after every 12 months. This gives you the flexibility to use the extra savings for something else if a more pressing expense arises. If you do this starting the first month after getting a 30-year mortgage for $200,000 at 4.5 percent, that would save more than $27,000 interest, and you would pay off the mortgage four years and three months earlier.
4. Throw found money at the mortgage
Are you expecting a bonus, a tax refund or an unexpected windfall? Whatever way it winds up in your hands, consider funneling some or all of your newfound money toward your mortgage. If you got a 30-year, fixed-rate mortgage for $200,000 at 4.5 percent, then, five years later you can make an extra $10,000 lump-sum payment. Doing so pays off the mortgage two years and four months earlier, and saves more than $19,000 in interest. The upside: You’re paying extra only when you’re flush. And those additional payments toward the principal will cut the total interest on your loan. The downside: It’s irregular, so it’s difficult to predict the mortgage payoff date. If you throw too much at the mortgage, you won’t have money for other needs.
