Paying Down Your Mortgage First
Let’s say youre finally in the home stretch with a mortgage you took out years ago. Its been a long haul, and youre tempted to pay it off in one final payment and finally be free and clearor, at least, accelerate your payments a little to be done sooner.
While it may seem tempting to pay down your mortgage near the end, its actually better to do so at the beginning. Although you make the same size payment each month , most of your money in those early years is going toward interest and doing little to reduce the loan’s principal.
So by making extra payments early onand reducing the principal on which you’re being charged interestyou could pay considerably less in interest over the life of the loan. The same principles of compound interest that apply to your investments also apply to your debts, so by paying down more of your principal early, the savings are compounded over time.
By contrast, in the later years, your payments are going more toward the loan principal. Paying more wont reduce your total interest burden as quickly itll just build your equity in the home faster . Not that theres anything wrong with that, but were looking for the best uses for your money.
It’s A Question Of Whether You Save Or Whether You Overpay Your Mortgage
With savings rates near rock bottom, overpaying on your mortgage is often a no-brainer as it’s an easy way to save £10,000s in interest. But it’s not right for everyone you’ll lose access to the cash and could face repayment penalties. This guide helps you decide if it’s right for you.
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Reasons #4 And #: Your Mortgage Interest Is Tax
A question people often have is, Should I pay off my mortgage or invest? But those two choices arent mutually exclusive.
The interest you pay on loans to buy, build or substantially improve a qualified residence is tax-deductible if you itemize your deductions. The deduction is taken at your top tax bracket. Thus, if youre in the 35% tax bracket, every dollar you pay in mortgage interest saves you 35 cents in federal income taxes. You save on state income taxes too.
Say youre in the 32% tax bracket and you get a 3% mortgage. That loan costs you 2.04% after taxes. Meanwhile, say you invest money and earn 3%. Your profits are taxed at only 15%, meaning your after-tax profit is 2.55%. Thus, even if your investments earn no more than what you pay for your loan, youre still making a profit!
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Should You Choose A 15
Theres a good reason that 30-year mortgages are typically the more popular choice for homeowners they come with lower monthly payments and can provide more purchasing power. While 15-year mortgages do have some advantages, especially when it comes to paying less overall interest, the higher monthly payments may be difficult for most borrowers to swallow.
However, if you do end up with a 30-year mortgage, its a good idea to try to make extra payments on your loan each year if you can. You can either plan out a faster overall payment plan or just make an extra payment whenever you have the money. Either way, those extra payments will help you save on interest, pay off your mortgage quicker and potentially give you the best of both worlds.
Make Extra Principal Payments
Another way to pay off your home loan faster is to simply pay extra when youre able.
Most mortgage loans issued after Jan. 10, 2014, do not charge prepayment penalties.
This means you can pay extra money toward your mortgage balance each month or make a larger, lump sum payment on your principal each year without facing a penalty for paying off your loan early.
Many homeowners make extra payments on their loans principal when they get an income tax refund. Extra principal payments can have a big impact.
Heres an example.
- Lets say you took out a home loan for $300,000 on a 30year term and rate of 4%
- Thats a principal and interest payment of $1,370
- 360 payments of $1,370 per month means youll have paid $492,500 over the life of the loan thats $192,500 in interest payments over 30 years
Using the same numbers for the loan amount and interest rate:
- If you make extra principal payments of $250 per month, youd shave seven years and four months off your term
- And, youd save more than $59,000 total in interest payments
There are benefits aside from interest savings, too.
Paying off your mortgage early lets you use the money you would have paid each month for other purposes, like investing.
Lets continue with the example above. Instead of paying $1,370 per month on the mortgage, you could put the same amount of money in an investment account.
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Easier To Get Positive Cash Flow On A Rental Property
If youre buying a rental property, or if you might convert your personal residence into a rental later, itll be easier to turn a monthly profit on the property with a longer mortgage term and a lower monthly mortgage payment.
In order to get positive monthly cash flow from a rental property, the rental income needs to exceed the propertys monthly expenses, repairs and mortgage payment, explains Mescher. With a 30-year mortgage, the monthly payment is less, so you can achieve positive cash flow even when the rental income is lower, she adds.
How Do Mortgage Payments Work
When you take out a mortgage, youre borrowing money to buy or refinance a home. You make regular payments to repay this loan, usually monthly. The amount you borrow is the loan principal.
With each payment you make, you’ll be paying off part of the principal amount and part of the interest. The interest is what the lender charges for loaning you money to buy a house.
Depending on the type of mortgage you have, your payments are usually consistent in amount and made monthly. In the beginning, the majority of your payments will be used to pay off the interest on your loan. As this amount reduces, more and more of your payments will start applying to the principal the actual amount you borrowed. This means that for the first few years of your loan, your payments are focused on paying off interest rather than principal.
If you apply additional payments to your principal to bring the amount down, the interest paid on the balance goes down as well because interest is calculated based on the principal balance. The goal for anyone looking to make additional payments on their mortgage should be paying down as much of the principal as possible.
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Pay Your Mortgage More Often
Often, people opt for monthly mortgage payments because it feels simpler and makes it easy to remember. But increasing the frequency of a payment to a bi-weekly or weekly timeframe will lower both your interest and outstanding balance sooner.
How? Increasing the frequency of the payment reduces the time for interest to accrue. If youre buying a million-dollar home in a competitive market, you already have a lot of expenses ahead of you. So any additional interest payments can really start to add up.
Shop For The Best Rate
Quite often, then, buyers will stick with banks or financial institutions they already know and have accounts with. But when shopping for the best mortgage rate, its actually better to cast your net wide and far. Consider outside-of-the box lenders, including credit unions and mono-lenders , as quite often these institutions can offer much better rates and terms than big banks.
Four Alternatives To Paying Extra Mortgage Principal
Before you begin making extra principal payments on your mortgage, its best to consider your overall financial goals. Consider how long you plan on living in the home. Assess any money that you can foresee needing in the future . And determine any current debts you are still paying on.
Assessing your current financial position and your future goals will help identify the ideal use for additional funds or maybe even prove that paying more on your mortgage is advantageous.
So, conversely, what are the alternatives , and what could the benefits be?
Reduce Your Interest Payments
As you pay off your mortgage, the first payments you make primarily go toward the interest on your loan. The longer that you carry your mortgage, the more youll have to pay in interest over time. Choosing to pay your loan off early can help you save a significant amount of money by avoiding additional interest charges. This is especially true for homeowners who had locked their mortgage into a higher interest rate originally.
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Funding Your Retirement First
Unfortunately, while its better to pay a mortgage off, or down, earlier, its also better to start saving for retirement earlier. Thanks to the joys of compound interest, a dollar you invest today has more value than a dollar you invest five or 10 years from now. That’s because it will be earning interestand the interest will be earning interestfor a longer period of time. So each year you delay saving for retirement will hurt you a disproportionate amount.
For that reason, it generally makes more sense to save for retirement at a younger age than it does to pay down a mortgage sooner.
Of course, investments dont just rise they fall, too, and their performance can fluctuate wildly with the financial markets. The returns, alas, arent usually as fixed as mortgage payments are. But thats all the more reason to start investing sooner rather than later. Your portfolio has more time to recover from roller-coaster behavior by the market. And the stock market has historically risen over the long term.
When Balancing Early Mortgage Repayment And Other Financial Responsibilities Works
You should have a robust household emergency fund before you think about paying extra cash toward your mortgage. An unexpected auto bill, medical expense or other cost can upset your budget if you dont have any liquid cash.
While its possible to take cash out of your home equity with a refinance, this process takes time, which you may not have in an emergency. Make sure you have plenty of money set aside for emergencies before you put any extra toward your mortgage loan.
You may also want to put off paying off your mortgage if you have another big expense coming up. Your priority should be putting money into your 401 or IRA. You might also want to consider diverting your extra money into a childs college fund or into savings for an upcoming vacation or wedding.
Theres no point in paying off your mortgage if it means going back into debt in the future.
See how much cash you could get from your home.
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Investing The Cash Instead
If you have excess cash burning a hole in your pocket, consider the opportunity cost of paying down your mortgage early instead of using the funds to invest elsewhere. While you will save on a portion of the interest expense, you may be better off investing the money instead, especially if your interest rate is low.
Consider your interest expense relative to your long-term return expectations. If a homebuyer can get a 30-year fixed mortgage for 2.85% and their long-term assumption for investment returns is 6%, theyre using leverage to achieve a better financial outcome. After all, you won’t enjoy the benefits of paying down your mortgage early until you’re living debt-free, but the average buyer only lives in the house for 10 years.
Why Pay Off Your Mortgage Early
Few people keep a 30year loan for its full term. In fact, homeowners stay put just 13 years on average and their loans might have an even shorter lifespan if they refinance at some point.
Homeowners who plan to sell their home or refinance soon usually arent concerned about paying off their mortgage early.
But what about homeowners who stay put for the long haul? Those 30 years of interest payments can start to feel like a burden, especially compared to the payments on todays lowerinterestrate loans.
You may find yourself wondering how to pay your mortgage off faster so you can live debtfree and have full ownership of your home.
Here are five strategies you can use to meet those goals.
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Paying Extra Is The Cheap Easy Way To Pay Off Your Mortgage Early
If you have a mortgage, chances are its a 30year loan. And thats a long time to pay interest.
Many homeowners cant afford refinancing to a shorter, 15year loan term because payments are quite a bit higher.
But theres a way to pay off your mortgage early without any fees or penalties.
Just pay a little extra on your mortgage when youre able.
Can You Pay Off A Mortgage Early
Yes, its possible to pay off your mortgage early. In fact, doing so can help you save a great deal of money in the long term. Making extra payments, even if just in small amounts, can help you own your home outright sooner. Extra payments, refinancing or adjusting your repayment schedule can be useful methods for paying off your mortgage earlier.
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Recap Of Ways To Pay Off Your Mortgage Faster
If you decide you want to pay off your mortgage early, ask your mortgage lender about:
Whatever you choose, make sure youve weighed all your options to find the best use for your hardearned cash.
Make One Extra Mortgage Payment Each Year
Making an extra mortgage payment each year could reduce the term of your loan significantly.
The most budget-friendly way to do this is to pay 1/12 extra each month. For example, by paying $975 each month on a $900 mortgage payment, youll have paid the equivalent of an extra payment by the end of the year.
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Divert All Bonuses And Found Money To Your Mortgage Payment
Probably the least painful way to pay down your mortgage faster is to divert any found money toward your balance. Found money typically refers to money that is either unexpected or outside of your normal wages, such as an annual bonus, a lottery win or an inheritance. Since you arent counting on using that money as part of your monthly or annual budget, it is excess.
Rather than using it as splurge money for a lavish vacation or another indulgence, divert that money to your mortgage balance. Its essentially the same as making extra mortgage payments, except it has the added advantage of not coming out of your regular cash flow. This can make this strategy much less financially painful than having to carve extra mortgage payments out of your budget.
What Is A Prepayment Penalty
A prepayment penalty is a fee that your mortgage lender may charge if you:
- pay more than the allowed additional amount toward your mortgage
- break your mortgage contract
- transfer your mortgage to another lender before the end of your term
- pay back your entire mortgage before the end of your term, including when you sell your home
Your lender may also call the prepayment penalty a prepayment charge or breakage cost.
Prepayment penalties can cost thousands of dollars. Its important to know when they apply and how your lender calculates them.
If you have an open mortgage, you can make a prepayment or lump-sum payment without paying a penalty.
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Mistakes To Avoid When Paying Off Your Mortgage Early
If you can afford to pay off your mortgage ahead of schedule, youll save some money on your loans interest. In fact, getting rid of your home loan just one or two years early could potentially save you hundreds or even thousands of dollars. But if youre planning to take that approach, youll need to consider if theres a prepayment penalty, among other possible issues. Below are five mistakes that you should avoid when paying your mortgage off early. A financial advisor can help you figure out your mortgage needs and goals.
Bring Your Lunch Into Work
Sure, bringing an egg salad sandwich to work every day isnt as fun as going to a restaurant with your coworkers. But trading lunch out for eating in can make you a lean, mean, mortgage-free machine.
Suppose packing your lunch frees up $100 to use toward your mortgage every month. Based on our example above of the $220,000 loan, that $100 in lunch money will help you pay off your mortgage four years ahead of schedule and save you nearly $27,000 in interest!
Cant quite spare a whole $100 from your food budget? No worries. Even small sacrifices can go a long way to help pay off your mortgage early. Put Andrew Jackson to work for you by adding just $20 to your mortgage payment each month. Based on our example, youll pay your mortgage off a year early, saving over $6,000 in the process.
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