If you’re a homeowner, and you have a long-term financial plan, you should include a strategy to pay your mortgage off early. If you can, you’ll have more money each month to pay off non-housing debt, or to build up long-term savings to fund your children’s college education, or to prepare for your retirement. And speaking of retirement, you’ll want your mortgage gone by the time that day arrives, that way you won’t need nearly as much income and your retirement portfolio will last much longer. Also, to proctect yourself, it is a great idea to carry mortgage protection insurance, we can help you find the best for your needs!
Here are four ways to pay off your mortgage early that you’ll hardly even notice. Use one or a combination of two or more, and you’ll be mortgage-free well ahead of schedule.
Refinance to a Mortgage with a Shorter Term
With mortgage rates currently in the 4.something range, this can be the simplest way to retire your mortgage early. The idea is to refinance your loan, but reduce the term by at least five or 10 years. By doing so, you can convert a 30 year mortgage to a 25 year loan, or even a 20 year term.
As simple as this method is, there are some caveats to be aware of should you decide to go this route:
- You don’t want to refinance if it will result in an increase in your interest rate of something on the order of one percent or more. There’s a point where a higher rate will offset the benefits of a shorter term.
- You don’t want to add closing costs to the new loan balance – doing so will only increase your monthly payments, and make paying off the loan more difficult.
- The term reduction must be based on the number of years remaining on your mortgage as of today. For example, if you are three years into a 30 year mortgage (meaning you have 27 years remaining on the term), and you want to reduce the term to that of a 20 year loan, you’ll have to refinance the new mortgage as a 17 year loan.
Keep each of these points in mind should you decide to do a term reduction refinance. Also, it’s probably not worth refinancing if you expect that you will be moving out of the house in less than five years.
Set up a Bi-weekly Payment Plan with Your Mortgage Holder
With a biweekly mortgage payment, you will make your house payment every two weeks, rather than once a month. At first glance it doesn’t seem as if that will make much difference. But it actually has the effect of making you pay the equivalent of one extra monthly payment per year. And that difference in the annual payment can chop several years off the remaining term of your loan.
For example, if you simply cut your mortgage payment in half each month, but make two payments per month, you’d be making 24 payments per year. But with a biweekly mortgage, your payments are made every two weeks, which works out to be 26 payments per year. It’s based on the fact that while you are making two payments every 28 days, there are actually 30 or 31 days in most months.
The net effect is that instead of making 12 payments per year, you’re actually making 13. That 13th payment goes entirely to principal, which is why your loan pays down faster. On a 30 year mortgage, this will typically take four years off the loan term.
One of the disadvantages to a biweekly mortgage is that if you don’t already have one, you generally will have to refinance your current mortgage in order to establish one. That’s because every small detail of your mortgage is a legally recorded contract; if you change even a single item you’ll have to change the contract, and that requires a refinance.
Make One Extra Mortgage Payment Each Year
But there’s an easier way to get the benefit of the biweekly mortgage, without having to refinance your current mortgage into one. You can simply make one extra mortgage payment each year, and that will achieve the same result.
There are different ways that you can make a 13th payment each year, but the least noticeable will simply be to allocate extra money into a dedicated savings account – kind of like an emergency fund, but one set up for the specific purpose of making an extra payment on your mortgage each year.
For example, if your mortgage payment is $1,500, you can put $125 ($1,500 divided by 12 months) into the dedicated savings account. Then at whatever time of the year you determine as the date to make the extra payment, you’ll have the money available.
Why do this, rather than simply add it to your monthly payment? Because putting money into a savings account seems less painful than increasing your monthly payment. It will also give you the opportunity to tap the account should the funds be needed for an emergency purpose. That’s more of a psychological advantage than a real one, but then personal finance always involves an element of psychological warfare – with yourself!
Apply Cash Windfalls to Your Mortgage Balance
This can be the most effective fast-payment method you can use to pay off your mortgage early. That’s because you don’t have to save up for it, you don’t have to increase your monthly payment, and you don’t have to refinance your mortgage. You simply take any extra money you have and apply toward your mortgage balance. Your regular monthly budget will never be disturbed.
There are probably more opportunities to do this than you are generally aware of. The most obvious is using your income tax refund for this purpose. According to the IRS, the average tax refund is around $3,000. If your refund tends to be in that average range, that will be a more effective way of paying off your mortgage than making extra mortgage payments, or even increasing your monthly payment.
But don’t stop with your income tax refund. You can also use bonus money from work, or even cash from the sale of any personal effects that you might sell at a garage sale or through eBay or on Craigslist.
If you get really serious in this effort – and put any refund you receive toward your mortgage – you could very well cut a 30 year mortgage into a 15 year mortgage.
Then start thinking about what you can do with all the money you’ll have as a result of not having a mortgage for 15 years.