5 Ways to Pay Off Your Mortgage Early
April 25, 2013
Next to achieving a fully funded self-directed retirement account, paying off your mortgage early is probably the Holy Grail of personal finance success. As well it should be â€“ once youâ€™ve paid off your mortgage, your monthly living expenses take a dramatic drop. That opens up the opportunity to save even more money than you ever have in the past.
Since paying off your mortgage early is so desirable, what are some ways to do it without having to completely rearrange your finances?
1. Refinance the loan to a shorter term.
One of the most efficient ways to pay off your mortgage early is to refinance the loan to a shorter-term. Letâ€™s say that you have 25 years remaining on what was originally a 30-year loan. By refinancing your mortgage to a 15-year term, you chop 10 years off the term with a single action.
This works especially well if you lack the discipline to use other methods to pay off your mortgage early. Since your new loan amount will be fixed, youâ€™ll be forced to make a higher payment that will retire the loan in much less time.
The downsides of refinancing are that (a) you will have to pay closing costs in order to do it, and (b) itâ€™s a strategy that wonâ€™t work if rates are higher than what they are on your original loan. In fact, youâ€™ll probably be entirely unlikely to refinance if your interest rate will increase even a little above what you have now. In the right rate environment, refinancing will work well. But if rates are running against you, you may have look at other means.
2. Increase your mortgage payment by the same amount each month.
This is perhaps the simplest way to pay off your mortgage early. You simply increase your monthly mortgage payment by a specific amount that works well for you, and gradually chop years off the term of the loan by doing so. If you ever hit upon a cash flow problem, you can always revert back to the original payment.
Letâ€™s say that you have a $200,000 mortgage for 30 years at 4%, and your monthly payment is $955. If you took the loan in 2013, it will be paid off in 2043. But look what happens if you add just $100 of extra principal each month: the loan will be paid off in 2038 â€“ five years ahead of schedule.
If you add $200 in extra principal each month the loan will be paid off by 2034, or nine years ahead of schedule.
You can run different payment scenarios by using a mortgage amortization calculator. It will help you to find an extra payment amount that fits neatly within your budget.
3. Make one extra payment each year.
Using a biweekly mortgage payment plan is another way to pay off your mortgage sooner. Some mortgage lenders will allow you to set up such a plan on an existing loan, however others may require that you refinance specifically into a biweekly mortgage.
But you can achieve the same result without having to enter into a formal biweekly mortgage payment plan. The net effect of a biweekly mortgage is that you end up making approximately one extra monthly payment per year. You can do this on your own, simply by quite literally making one extra mortgage payment per year.
To show you how that works mathematically, with a biweekly mortgage, youâ€™ll make 26 payments per year. If you divide the 26 payments by two, you get 13 monthly mortgage payments. You can make that 13th payment without having a biweekly mortgage.
Using the same mortgage example that we used above, if you make one extra mortgage payment per year â€“ $955 â€“ youâ€™ll reduce your mortgage term by a full four years (2039 vs. 2043).
4. Pay it off in chunks.
If you donâ€™t have the discipline to make additional monthly principal payments, you can also pay off your mortgage in chunks. Most of us have some extra cash come in on a fairly regular basis. If instead of spending extra money on other purposes you use them to prepay your mortgage, youâ€™ll be well on your way toward paying off your mortgage early.
Using your tax refund is an excellent source. The average tax refund in the U.S. is a little bit higher than $3,000. But say that you redirect your refund into your mortgage each year. By doing so, instead of paying off your mortgage in 2043, you will pay off in 2033 â€“ 10 years ahead of schedule. Youâ€™ll have effectively converted a 30-year mortgage into a 20-year mortgage without having to refinance, or make additional principal payments every month.
5. Set up a â€œsinking fundâ€ to retire your mortgage.
If you are a saver by nature, this could be the preferred choice for you. You simply create a dedicated savings account for the purpose of paying off your mortgage early. Just as you would with any other savings plan, you will make monthly contributions to the account until you reach the point where the balance in the account is sufficient to payoff your mortgage completely.
Businesses and institutions use this method to retire bond issues. The strategy is referred to as a sinking fund in the business world.
This has at least two major advantages:Â It allows you to keep your mortgage interest tax deduction maximized until the day you pay off your mortgage, andÂ it enables you to have control of the funds prior to payoff, which will give you options in the event that your plans or circumstances change.
You should be able to use at least one of these strategies to pay off your mortgage early. At least one of them should fit within your budget and your personal preferences.
Have you tried any of these strategies? What other methods can you suggest to pay off your mortgage early? Leave a comment!
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All posts by Kevin Mercadante