Living debt-free can seem like an elusive dream to most Americans.
The average household in the US is drowning in almost $17,000 of credit card debt. Add that to the fact that most home mortgages are set up on a 30-year repayment schedule. That means that if you buy a house in your 20's, you'll be in your 50's before you pay it off!
Do you really want to wait that long to be debt-free?
You don't have to. You can pay off your mortgage early. You may have to make a few sacrifices but you may be surprised at the payoff. Keeping reading to learn how.
Can You Pay Off Your Mortgage Early?
The first thing you should do is determine if you can pay off your mortgage early. What do we mean by this? Two things.
First, some mortgage companies will charge you a prepayment penalty for paying more than your monthly payment. Others may only allow you to make extra payments at specific times.
Be sure you find out your company's rules. Otherwise, you might not get as much benefit as you think by paying extra.
Second, you may be wondering if it is possible. After all, it's not like money grows on trees. Your monthly payment is already sizeable, how will you afford enough more to make a difference?
This is where understanding amortization is important. Let's say you have a $200,000 loan at 5% interest. In 30 years you will have paid $186,511.57 in interest. That's almost equal to your original loan amount!
But repayment schedules are amortized. That means that each month you pay more interest and less principal on a higher balance.
In this example, you pay $240 towards principle and $833 towards interest each month in the beginning. As the loan continues you pay slightly more principal and slightly less interest each month, but it takes a long time.
That means that even just an extra $100 a month can go a long way. You would pay the loan off 5 years sooner and pay $149,442,54 in interest.
Check out this amortization calculator. You can put in your data and see how adding extra will affect your particular loan. Find out how adding a little extra monthly, or once a year, or a one-time payment will affect your loan.
Should You Pay Off Your Mortgage Early?
The next thing you should consider is whether you should pay off your mortgage early. At first, you might think that this is a silly point. Isn't it always better to get out of debt if you can?
In most cases, that's true. Especially with high-interest debt like credit cards. In the case of mortgages, however, it isn't always.
Well, mortgage interest rates are some of the lowest interest rates available for loans. You should always pay off the loan with the highest interest rate first. Thus, if you have other debts with a higher interest rate, focus on paying those off first.
In some cases, your mortgage interest rate may be lower than the interest rate on a 401(k) or another type of investment. That means you would actually earn more by putting any extra money into the investment.
Another thing to consider is how close your kids are to college. A paid-off home actually counts against you when applying for need-based college aid. Any equity that you own in your home is considered money in the bank.
How To Pay Off Your Mortgage Early
Now that you've decided you want to pay off your mortgage early, how are you going to do it? Money isn't just going to appear out of the woodwork because you decided you want to pay it off.
Keep reading for several tips on how to pay off your mortgage early. It might not be a difficult as you think.
Pro tip: Whenever you send extra money to the mortgage company be sure to include a note specifying you want it to go to the principal. Otherwise, they just may apply it towards the interest in your next month's payment.
1. Refinance To a Shorter-Term Loan
The longer you have to pay a loan back, the more you will pay in interest. Remember how much you pay in interest on $200,000 at 5% for 30 years? $186,511,57.
Those same terms on a 15-year mortgage will cost you about $500 more a month. But, you'll pay it off 15 years faster and only pay $84,685.71 in interest. You save $100,000! That's nothing to sneeze at.
2. Pad Your Monthly Payments
However, refinancing costs money too. It may be better to treat the loan like you refinanced it, without actually doing it.
Use the amortization calculator to find out what your payment would be and pay that instead. You'll have to have a bit more discipline with this method, but you can save yourself a lot of money.
Plus, if you have an emergency you can go back down to your normal payment until you get back on your feet. Just make sure it's a real emergency. Otherwise, you'll always have an 'emergency' and never make your goal payments.
If you're one of those people you might want to go with the refinancing option.
3. Make Bi-Weekly Payments
Another method is to 'trick' yourself into paying more. Divide your monthly payment in half and pay a half payment every two weeks.
When you pay once a month you pay 12 payments in a year. But every month doesn't have exactly 4 weeks in it. A half payment every two weeks adds up to 26 half payments or 13 payments in a year. Easy as pie!
4. Make One Extra Payment a Year
You can also simply make one extra payment each year. You will see slightly more savings through the bi-weekly method since you're knocking down the principal a tiny bit faster. But you may not like having to remember to pay the mortgage more often.
Go with whichever method works best for you. A method you can stick to is the key to success.
5. Put Windfalls Towards Your Mortgage
Every dollar extra that you pay goes directly to principal. That means that not only is your loan disappearing faster, but also you're saving the interest on that dollar.
Putting any extra windfalls you get throughout the year can go a long way towards being debt-free. Here are a few common examples.
A gift from a relative
A profitable garage sale
Here's one other thing that most people don't think about. If/when you get a raise, put the extra money straight into your mortgage. You won't even miss it because you were already used to not having it.
6. Use Your Lunch Money
What if there just isn't any extra money to add to your payment? You're going to have to make some sacrifices to find it.
Bring your lunch to work with you instead of buying it every day. You can easily find $100 a month right there. Remember what we said $100 could do?
This goes for any little expenses that add up. Do you buy coffee every day? Invest in a good thermos and brew it at home to bring with you.
Take a look at your daily habits, you'd be surprised how much money you can find with a few adjustments.
7. Cut Spending
You can also cut spending in other ways. Take a look at your monthly bills. How much of that stuff do you really need?
Cable bills are expensive. Go with the free channels instead. Or, if you have to have all the best shows, sign up for a streaming account like Netflix or Amazon Prime. They're generally much cheaper.
How much are you paying for car insurance? Does another company offer a better rate? Or, many companies offer a discount if you pay once or twice a year rather than monthly. You may find several hundred dollars sitting right there.
Get creative about slashing spending. Splurge in small ways every once in a while to keep enjoying life. And keep in mind that once you're debt-free you'll have extra money to enjoy a whole lot more splurging.
8. Increase Your Income
Are you really dedicated to making that mortgage disappear? You might want to look at ways to increase your income.
Work nights and weekends at a part-time or freelance job. Ask for overtime hours at your job. Take care of people's pets when they go on vacation. Sell stuff that you don't need.
Get creative with it. You might be surprised that with a little dedication you can increase your income by quite a bit.
What if all of this just isn't enough? What if there is really no way to pay off your mortgage early? Do you just give up?
There's one thing left that you can do. Admittedly, it's a drastic measure. But sometimes drastic measures are what you need to make things happen.
Move to a smaller home or a cheaper neighborhood. If you do this, be aware of how your transportation costs to work change. If you move farther out the extra time and money to get to work may negate the mortgage savings.
You Can Do It!
Above all, remember that you can do it. You may need to make some sacrifices here and there but the rewards are worth it.
Living debt-free is a dream that is attainable if you're willing to work for it. We can help with reasonable mortgage rates whether you're looking to refinance or purchase a new home. Contact us today to learn more!